Gold at low ebb, authorities in ascendance

If a rising price of gold is a negative indicator of trust in the global financial system, then the world’s central bankers and policy makers are right now enjoying a glittering authority. You might argue, and some will, that this confidence, reflected not just in the fall in the value of gold but in the buoyancy of the value of most financial assets, is misplaced. But the narrative of spiralling money creation and inflation that sold easily up until 2011 no longer retails well. Gold isn’t so much an asset class, much less a barbaric relic, but a kind of shorthand for a belief system. This is the idea that fiat money systems, where currency can be created by authorities at will, inevitably slope towards devaluation. To the extent that this happens little by little, gold tends to simply keep pace, rising a bit as paper money falls a bit. When people think central banks will wittingly or unwittingly engineer a runaway inflation, and with it devaluation of paper currency, then gold trades at a premium. Gold prices plunged to their lowest in more than five years on Monday, dropping as much as 4.5 percent before recovering slightly to US$1,109.75 per ounce. This compares to a peak above US$1,900 in 2011, when many investors sought to indemnify themselves against the inflation they thought quantitative easing would inevitably bring. The immediate cause of Monday’s down-draft was news that China’s central bank had amassed less of the precious metal as part of its reserves than analysts expected. The deeper, and broader, reason that gold is and has been falling is that policy in the U.S. is on the verge of beginning the long process towards more normal monetary policy. That the Federal Reserve can countenance raising interest rates, and is doing so when there is some doubt that inflation will recover enough to justify the move, says much about the financial state of the world. QE and ultra-low rates may or may not be a success as economic policy, but thus far they have not generated the devaluation and inflation that gold buyers feared. The prospect of higher rates also makes bonds more attractive relative to gold, which offers the hope of price appreciation but yields nothing. Anti-investment Interestingly, gold seems no longer to be playing its role as a safe-haven asset in times of uncertainty. When Greece threatened, as indeed it still does, to ricochet out of the euro it was German and U.S. government bonds which got a bump, as well as the dollar. You could not ask for a neater expression of the faith that investors place in authorities. In much of the world from Europe and Japan, where QE is on-going, to China, where the government is blatantly manipulating stock markets, authorities are taking extraordinary steps but enjoy, if not universal approval, at least near-universal faith that they will be able to do what they pledge. That’s partly, of course, because they’ve run these policies and the inflation gold investors feared never materialized. It is also because financial markets are peopled by agents who make a much better living when financial asset prices are rising. Trying to beat back against a tide of rising asset prices is an excellent way to run short of clients. There is a chance, of course, that this faith is excessive. Central bankers have kept control, but the underlying fundamentals of the economy are still a concern. U.S. total debt is more than three and a third times as big as economic output. While that’s down from the peak in 2010, it is still above where it was going into the financial crisis and an order of magnitude above historical norms. This implies that the motivation for a devaluation still exists, even if we have no real evidence that the current mix of policy will produce one. On one level we should be pleased gold is in the doldrums. It is really an anti-investment, something that only pays off when things go badly but which, in itself, improves nothing for anyone who does not own it. That’s in contrast to stocks, which can enrich investors and improve the lives of the workers and consumers affected by the company, or bonds, which, at least in theory, finance some useful project or spending. Too much central control of investment, such as the support offered by authorities for markets, will lead to less productive investments than otherwise. That, a period of low returns due to chronic official-inspired silly investment, is probably what we should fear more than the inflation worries that once supported gold.