Gold is Still the Old Normal

The German Finance Minister recently shared some fresh words for European monetary policymakers.

Wolfgang Schauble railed against the European Central Bank’s involvement in pushing interest rates below zero.

His complaint: It hurts savers and it hurts banks.

It sure can.

But proponents of negative interest rates and perpetual monetary stimulus are everywhere these days.

And their rebuttal sounds a lot like: "Yeah, and so does recession."

Indeed, the recession boogeyman is alive and well. Recession can and does hurt savers and banks, albeit for different reasons.

So this boogeyman still justifies extraordinary monetary policy, despite the fact you and I might want to fight back against that logic.

It is the new normal.

And it has been since — I don’t know — probably 2009 when G20 "coordinated efforts" began.

Interestingly, though, the new normal still very much depends on the old normal. And at the root of the old normal is gold.

About the Banks …

Perhaps contrary to popular belief, central banks don’t deserve the credit for excessive money-creation and low interest rates around the world.

They merely deserve credit for managing the perceptions of the masses. As long as the masses play along, the fluctuations in money supply and interest rates will not be a problem.

But that’s a big "as long as."

The world operates in a tightly coupled financial system. So policymakers’ task of maintaining stability through "perception management" is tough. There are many variables they must consider.

So, "as long as" these variables are anticipated, their efforts remain viable.

There is perhaps no bigger variable than the banks.

The banks create the money in the economy.

The banks are responsible for setting interest rates.

And the banks depend on those two factors facilitating economic activity.

When they don’t, well, it’s time for the campaign managers at the Federal Reserve and the European Central Bank to step in.

"Don’t worry, we have just the right tool to make money flow again."

"Don’t worry, recession is a much greater risk than a potential asset bubble."

"Don’t worry, we won’t let the global savings glut choke off economic growth."

"Don’t worry, we’ll make sure a mounting pile of bad loans is no big deal."

Alas, there we are.

Italian banks face a load of bad loans in the neighborhood of €300 billion. And that means the Eurozone faces a potential relapse of its Sovereign Debt Crisis circa 2012.

U.S. banks face the potential contagion of a potential European Sovereign Debt Crisis. And they’re already dealing with an annoying amount of pressure from bad loans they made to the U.S. energy industry.

JPMorgan (JPM) and Bank of America (BAC) last week reported on the negative impact their energy portfolios are having on their bottom lines. And it ain’t good.

Fiat currency is the new normal.

Banks suffer from the ebb and flow of confidence in their debt loads and exposure.

Economies get by with subpar growth levels at best.

Good inflation is absent. Bad inflation is plaguing the globe.

Markets, fueled by hope, are the only game in town.

This is the new normal even though it’s not that new.

This new normal is rooted in one thing that essentially came into being several decades ago: fiat currency.

In 1944, the Bretton Woods agreement created a fixed foreign-exchange rate system. It helped maintain currency exchange rates and allowed the International Money Fund (IMF) — formed due to this agreement — to correct payment imbalances.

The U.S. dollar was the world’s reserve currency. Which meant other countries had to peg their currencies (i.e., keep within 1% parity) to the dollar.

Bretton Woods officially replaced the gold standard with the U.S. dollar standard. However, the U.S. kept gold in the mix.

It agreed to link the dollar to gold at the rate of $35 per troy ounce of gold. One economist, Robert Triffin, observed the consequent "dollar glut" — that is, the accumulation of U.S. dollars outside the United States.

More than a decade later, U.S. President Richard Nixon officially recognized the downfall of the Bretton Woods system. Recognizing the limitations of a reserve currency tied to gold, Nixon halted convertibility of the U.S. dollar into gold.

From then until now, global banks have been free to use the fiat money of a free-floating exchange-rate system to manage the financial system.

It’s been the new normal, but  …

They Can’t Escape the Old Normal

The value of fiat currencies — the U.S. dollar and the euro, for example — are measured relative to one another.

From here, I’ll turn to some of the recent comments I sent to my paid readers …

Black & White and Gold

When fiat currencies are compared to other fiat currencies, the capacity for policymakers to manage exchange rates and avoid a currency crisis increases greatly.

It’s become popular to refer to this dynamic as "currency wars." But that term doesn’t work for me because it insinuates that policymakers are at odds.

On the contrary, the world’s most-important central banks have become quite dependent on working together. That’s thanks to the global interconnectedness of economies, and financial systems that depend on dollar-based liquidity flows.

I see gold as a tool to manipulate the perceptions of market and economic participants.

Because gold has a history of broad acceptance as a store of value, it is useful in measuring the acceptance of currency.

U.S. dollar assets such as Treasury bonds are backed by the full faith and credit of the U.S. government. The U.S. dollar is essentially a note with this same guarantee that the U.S. government is obligated to pay out on that debt.

So, if the value of the U.S. dollar is sinking relative to the value of gold — or the U.S. dollar value of gold is rising — what does that say about the full faith and credit of the U.S. government?

It doesn’t say anything good.

And it’s a lot harder for the government to manage the perceptions of economic and market participants when policymakers and their efforts cannot be trusted or reasonably expected to succeed.

Just as the history of gold as money depended on confidence, today’s monetary system depends on confidence.

Policymakers recognize gold is valuable. They still keep a good amount on hand because they understand the game they’re playing.

And policymakers prefer a backdrop of inflation when managing things. Inflation often coexists with some degree of economic activity plus a greater capacity to finance debts with a cheapened currency.

Gold is still the old normal.

It is the best way to measure the money-value of currency.

That’s why gold is valuable to policymakers who have everything resting on their ability to manage perceptions of the global financial system and economy.

That’s why it can be valuable to you, too.

Do right,

JR Crooks

Your thoughts on “Gold is Still the Old Normal”

  1. All that is well and good, but as long as governments are against business and profit, bury them in regulations growth will not occur. The people are scared to borrow for fear of loosing their jobs. A mountain of fiat money will not make the economy grow. The last nine years proves this.

  2. Don’t be silly. Governments want businesses to grow so they and the employees can be taxed on earnings. Name some regulations you want to drop. By the way, the economy -GDP is growing. It has grown every year after 2008.

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“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also …