DumbAgent.com

For this generation of investors, the paradigm that is ingrained is the concept of “boom times, crash, boom time restarts”.  The United States stock market is returning to relatively new highs due to the rally in stocks that has made some investors feel that “happy times are here again”.  This has created the psychology that the “boom time” has restarted as more individuals have used 0% interest rates and government financing to purchase cars, homes, and appliances. There is little thought given to the possibility of systemic collapse.

Unfortunately, it is another attempt to revive the system through government spending.  Due to the privileged status of having a reserve currency and years of economic prosperity, the United States was able to forego the inevitable bust for multiple decades.  The situation is analogous to a drug addict continuing to shoot up, refusing to cleanse himself of the toxins that harm his body.  The body can barely stand up, the addict wants to stop, but the doctor continues to recommend he continue his habit.

Crisis of Confidence

‘Confidence is the most important thing, more important than gold or currency’ – Wen Jiabao

Years of fiscal mismanagement coupled with lax oversight and enforcement have cast a blanket of uncertainty over basic rights in the United States.  Contract law was one of the most sacred tenements that world business leaders could depend on the United States to enforce.  The events in the past two years have made investors question the sanctity of their business agreements.  Mortgage modifications and government intervention have considerably raised the amount of risk of business transactions.  Lenders to the United States are now demanding higher interest rates since the government can now modify terms of an agreement in a loan.  Government intervention into interest rates have mispriced capital in terms of United States currency, and have forced investors to seek gains abroad. In investor’s minds, why allow the United States to borrow money at low interest rates when the risk has never been any higher?

The Silent Crash

Nominal prices in stocks look promising, but is it really a sign that boom times are here again? When measured in US dollars, it appears that the market has rebounded.  If we modify the measuring stick from US dollars to gold, a different picture emerges:

Gold

The performance of gold has outpaced stocks despite having the 30% correction during the Lehman Brothers crisis in 2008.  Recently, hedge fund managers David Einhorn and Paul Tudor Jones have allocated funds into the shiny metal.

When a currency is viewed as stable, money can stored as a store of value. However during times of overt monetization, hyperinflation, or when questions arise about the stability of a banking system, gold prevails as a more reliable store of value. Gold has an economic value even in the worst of times.
- Paul Tudor Jones

I have seen many people debate whether gold is a bet on inflation or deflation.  As I see it, it is neither.  Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible.  Gold did very well during the Great Depression when FDR debased the currency.  It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity.  It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.
- David Einhorn

Low interest rates create the risk that the United States could experience a currency crisis.  There occurs when there is no confidence in its currency to be a reliable store of value.  What makes this situation unique, is that a reserve currency is being both domestically and internationally scorned. It is the fear that the US dollar will be further debased which is causing capital to seek out gold.

Market Update

Many unfavorable factors lie ahead for the world economy.  This shift in the reserve status of the United States dollar is going to lead to transitions in power on the economic stage.  Exporting nations now have to deal with not having a trade consumer in the United States, and now have to find both internal and outside external markets to stimulate demand for products.  This will depend on whether the emerging economies will allow their currencies to rise after years of deliberately creating trade surpluses.  The two factors to watch will be the US dollar and the 30-year US treasury yield.  If foreigners are not buying United States debt, and the US policy does not change with regard to monetizing its debt, the money will flow towards alternative stores of value. As Martin Armstrong points out:

The deflation scenario requires a capital concentration to the dollar internationally. if the opposite takes place, we end up with inflation. It is hard to see a flight to the dollar today