April 14, 2011
Santiago, Chile
Doing his best to appear convincing yesterday, President Obama outlined his plans to make deep cuts to America’s budget deficit.
“If our creditors start worrying that we may be unable to pay back our debts, it could drive up interest rates for everyone who borrows money…” This is some of the clearest language we’ve seen yet– that official policy is to screw the people who work hard and save their money in order to benefit debt junkies.
Low interest rates, however, have had little positive effect. Unemployment is still painfully high, and inflation is now shifting into third gear.
The dollar falls almost daily to embarrassing record lows against world currencies, commodities… basically anything that’s NOT the US dollar… as institutional investors and money managers look for a better store of value.
The euro a questionable option. The dollar is fundamentally weak because of the US government’s ongoing efforts to debase the currency… but the euro is equally weak because of many member states’ economic fragility.
Portugal is officially broke, though Portuguese people refuse to accept budget austerity. Greek, bond yields are now over 13% as that country’s Finance Minister George Papaconstantinou hinted at debt restructuring. Spain is living solely by the grace of critical liquidity injections from China. Et cetera.
And then there’s Japan. Already in debt over 200% of GDP, post-tsunami spending will likely send debt levels surging. Furthermore, Japanese exports depend on a weak currency, and we have already seen world central banks coordinate efforts to weaken the yen when it rose beyond the low 80s versus the dollar.
Between these three currencies, the dollar, euro, and yen, total M2 money supply represents roughly $30 trillion, and the total size of their sovereign debt markets is even higher.
This provides plenty of liquidity for banks and money managers– if they lose confidence in the dollar, there’s a large enough market in euro and yen to move capital into those currencies without causing a major swing in prices.
Unfortunately, none of those three currencies is really a good option. Perhaps even more unfortunately, there is not enough liquidity in smaller, more suitable currencies to be able to absorb large capital inflows.
Singapore, for example, has a fairly sound currency and strong economy. The government has allowed its currency to appreciate in order to offset inflation, and the Singapore dollar has risen to an all time high against the US dollar of S$1.25.
Total M2 money supply in Singapore, however, only amounts to $325 billion, and the sovereign debt market is roughly $100 billion… far too small to absorb trillions of dollars in institutional wealth.
Money supply in Chile stands at $123 billion, $301 billion in Norway, $735 billion in Switzerland, and $1,200 billion in Australia. In total, these currencies are a drop in the bucket compared to the $30 trillion in dollars, euros, and yen.
Over time, have appreciated significantly. We’re seeing record highs in the Chilean peso, Swiss franc, Aussie dollar, etc. Eventually, though, governments will reach their breaking points and intervene. Even the soundest currency and strongest economy is susceptible to intervention.
Conversely, gold is one of the only stores of value that isn’t controlled by a single government authority; its price and value cannot be dictated by bureaucrats and politicians… and unlike the price of corn, rice, oil, and gas, the gold price is not politically sensitive.
With a total market size of roughly $8 trillion at today’s prices, gold is much larger than the basket of smaller currencies like the franc or peso… and devoid of any political sensitivity, gold is quickly becoming the preferred place to park capital.
Picking it up at its all-time high of $1470 may be psychologically difficult, but as long as world central bankers continue to print and debase their currencies, more and more money is available to flow into gold.
There’s no need to rush out and buy every ounce you can today; there will be ups and downs, particularly over the next few months as the market tries to figure out if/when QE3 will happen.
The long-term prospects for gold, however, are solid. The price of gold is fueled by increased debt, the expansion of money supplies and geopolitical instability, all of which are in abundant supply.
Despite what you hear about recovery, the fundamentals of the world’s economic problems have not been addressed… merely papered over with temporary magic tricks.
A real discussion of the challenges and solutions is years away, and until that happens, trillions of dollars more will be printed, a great deal of which will flow into the gold market.
In a future letter, I’ll tell you why you should store it overseas.
