Let me start this article with a quote by Ludwig von Mises, famous economist of the Austrian School of Economics, on the subjects of credit expansion and economic cycles.:
¨(An economic) boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, as in all other cases of unlimited inflation, ends in a ¨crack-up boom¨ and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis… (a) depression follows in both instances.1
We have recently had enormous credit expansion over the past decade (see my earlier blog: ¨Have we learned the lessons of 2008?¨, which makes the case that rather than tightening the fiscal belt since 2008, there has been a vast global increase in credit, not only in absolute terms, but also expressed as a percentage of GDP. In addition to credit expansion, we have had enormous monetary expansion, with Central Banks all over the world printing vast amounts of fiat currency, ¨quantitative easing¨ being one of the creative techniques that Central Banks used all over the world to dig us out of the 2008 crisis.
Keynesians would argue that in times of economic boom, fiscal policies should be tightened. Yet we are into the longest economic expansion in modern history, yet in December 2017 the US Government significantly cut taxes, further fueling the economic boom. .
Attempts of the US Fed to raise interest rates do not seem to have support of the executive branch (witness Donald Trump´s recent tweets on the subject). No politician wants the economy to collapse under his or her watch. The Fed fully realizes that raising interest rates would take away the punch bowl that keeps the party going, hence without political backing seems unwilling to administer the tough medicine.
Basically, what von Mises is saying: the longer we take to remove the economic stimuli, the more pronounced the downward adjustment will be.
Given that global debt levelsare considerably higher than debt levels that triggered the 2008 recession, given that since 2008 there has been a huge dose of quantitative easing, there is a risk that the next recession may be more severe than the last. It may even result in a significant loss of confidence in fiat currencies. I am not saying this is a probability any time soon; I am saying this is a possibility, at some point in the future, that should be reckoned with. Forecasting the next recession or depression is like forecasting the next earthquake on the San Andreas Fault. We know tectonic forces are building, both geologically and economically, but neither geology nor economics are, in my opinion, precise enough sciences to predict timing of such cataclysmic events.
The next question: if there is a significant loss of confidence in fiat currencies, what takes its place? My best guess would be gold:
¨Imagine you have an assignation in New York. You have not been told where you should meet the other person and she has not been told where to meet you. You have no understanding of where to find her or where she might usually be found. She is as ignorant of you. You cannot communicate. You must somehow guess how to find each other and make those guesses coincide. Where should you go? And at what time of day?
A good answer is Grand Central Station at noon… Now imagine the world economy goes into a tailspin. There is a panic selling of risky assets. Where should you seek safety? Cash is the most liquid asset; but which kind? The dollar is a natural focal point. Yet America´s fiscal indiscipline and its sizeable current-account deficit might give pause. Other currencies have their faults, too. There is one other destination you might consider, if only because others are starting to think the same way. And that is gold.1
Warren Buffet eloquently expresses the case for utter disutility of gold: ¨Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their heads.¨
Much as I respect Buffet, gold has acted as a Grand Central Station since at least Roman times. In my own family´s history, my uncle (who posthumously was awarded the Yad Vashem prize for helping dozens of Jews escape World War II Hungary, without compensation), on his first visit to New York in the early 1970´s, was amazed at how super-wealthy one of the assisted families had become. They attributed their head start to a small bag of gold coin they had taken with them.
To quote Buffet again, yes, an investment in gold amounts to ¨going long on fear¨. But then again, there is much to be fearful about in the world today (see my first article on gold, which also makes the case that risk in the world today is higher than five or 10 years ago, explains that owning a percentage of gold in one´s portfolio can provide a higher return with lower risk). And then again, if one believes risk is underpriced in the world today, why not invest in gold? Even Buffet was invested in 130 million ounces of silver for many years.
Disclosure:Les Nemethy is long on gold coin, gold miners, and gold royalties. The author wrote this article, which expresses his own opinion. He is not receiving compensation for this article (other than from Seeking Alpha). And has no business relationship with any company marketing or selling gold. This article should not be construed as investment advice.
We have recently had enormous credit expansion over the past decade (see my earlier blog: ¨Have we learned the lessons of 2008?¨, which makes the case that rather than tightening the fiscal belt since 2008, there has been a vast global increase in credit, not only in absolute terms, but also expressed as a percentage of GDP. In addition to credit expansion, we have had enormous monetary expansion, with Central Banks all over the world printing vast amounts of fiat currency, ¨quantitative easing¨ being one of the creative techniques that Central Banks used all over the world to dig us out of the 2008 crisis.
Keynesians would argue that in times of economic boom, fiscal policies should be tightened. Yet we are into the longest economic expansion in modern history, yet in December 2017 the US Government significantly cut taxes, further fueling the economic boom. .
Attempts of the US Fed to raise interest rates do not seem to have support of the executive branch (witness Donald Trump´s recent tweets on the subject). No politician wants the economy to collapse under his or her watch. The Fed fully realizes that raising interest rates would take away the punch bowl that keeps the party going, hence without political backing seems unwilling to administer the tough medicine.
Basically, what von Mises is saying: the longer we take to remove the economic stimuli, the more pronounced the downward adjustment will be.
Given that global debt levelsare considerably higher than debt levels that triggered the 2008 recession, given that since 2008 there has been a huge dose of quantitative easing, there is a risk that the next recession may be more severe than the last. It may even result in a significant loss of confidence in fiat currencies. I am not saying this is a probability any time soon; I am saying this is a possibility, at some point in the future, that should be reckoned with. Forecasting the next recession or depression is like forecasting the next earthquake on the San Andreas Fault. We know tectonic forces are building, both geologically and economically, but neither geology nor economics are, in my opinion, precise enough sciences to predict timing of such cataclysmic events.
The next question: if there is a significant loss of confidence in fiat currencies, what takes its place? My best guess would be gold:
¨Imagine you have an assignation in New York. You have not been told where you should meet the other person and she has not been told where to meet you. You have no understanding of where to find her or where she might usually be found. She is as ignorant of you. You cannot communicate. You must somehow guess how to find each other and make those guesses coincide. Where should you go? And at what time of day?
A good answer is Grand Central Station at noon… Now imagine the world economy goes into a tailspin. There is a panic selling of risky assets. Where should you seek safety? Cash is the most liquid asset; but which kind? The dollar is a natural focal point. Yet America´s fiscal indiscipline and its sizeable current-account deficit might give pause. Other currencies have their faults, too. There is one other destination you might consider, if only because others are starting to think the same way. And that is gold.1
Warren Buffet eloquently expresses the case for utter disutility of gold: ¨Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their heads.¨
Much as I respect Buffet, gold has acted as a Grand Central Station since at least Roman times. In my own family´s history, my uncle (who posthumously was awarded the Yad Vashem prize for helping dozens of Jews escape World War II Hungary, without compensation), on his first visit to New York in the early 1970´s, was amazed at how super-wealthy one of the assisted families had become. They attributed their head start to a small bag of gold coin they had taken with them.
To quote Buffet again, yes, an investment in gold amounts to ¨going long on fear¨. But then again, there is much to be fearful about in the world today (see my first article on gold, which also makes the case that risk in the world today is higher than five or 10 years ago, explains that owning a percentage of gold in one´s portfolio can provide a higher return with lower risk). And then again, if one believes risk is underpriced in the world today, why not invest in gold? Even Buffet was invested in 130 million ounces of silver for many years.
Disclosure:Les Nemethy is long on gold coin, gold miners, and gold royalties. The author wrote this article, which expresses his own opinion. He is not receiving compensation for this article (other than from Seeking Alpha). And has no business relationship with any company marketing or selling gold. This article should not be construed as investment advice.
1Mises, L.v. (1940), Interventionism, p.40
2Economist, Feb 23, 2019
2Economist, Feb 23, 2019