So 2012 will mark the fifth anniversary of the global financial crisis and
theres little reason to think it has reached its end yet. Merry Christmas.
Banking and household leverage in the rich West has barely ticked lower from the
credit bubbles historic peak of 2007. Financial leverage has only been reduced
by a fraction, while governments have been stuffed like a French goose with that
new debt spurned by the private sector since 2008. So why this slow, seemingly
permanent pain? Because interest rates are still set at zero, with no uptick in
sight an emergency measure thats now etched in stone. There is a lot of
financial stress out there, U.K. insolvency specialist Begbies Traynor moaned
last week . (But) if it wasnt for low interest rates, the number of insolvencies
would have been twice what they are. Twice as many debtors would have enjoyed a
write-down, in short. But do you really think their creditors sleep any better
knowing whats keeping debtors in debt? The gambit of low rates first played in
mid-2007 and now stuck comes from studying the Great Depression of 80 years
ago. If only the Federal Reserve had slashed rates to zero, then todays central
bankers could have avoided the deflation of their grandparents. Low teaser rates
under Alan Greenspan have thus become permanently low revolving rates under Ben
Bernanke. Which is where the mechanics of this depression stands apart from the
downturn of, say, 30 years ago. Back then, central bankers imposed deflation by
hiking short-term interest rates toward 20% per year. Today, the credit crunch
is priced only into the weakest balance sheets, and in the interbank lending
market, where liquidity has vanished again in 2011. Contrast with the early
1980s depression, when bond yields badly lagged policy in forcing through the
deflation. Ten-year U.S. Treasury yields, for instance, broke into double digits
10 months after the Federal Reserves overnight target rate breached that level.
It wasnt until 1983 that the curve reverted to normal, with 10-year bonds
offering a higher rate of return than overnight credit held at the Fed. Click to
Enlarge The impact of this policy-driven deflation? A rise in the dollar so
strong both in real purchasing and forex conversion terms that it unwound all
of gold s plunge for non-dollar investors. That were living through deflation
again today is plain, no matter how far the Fed and other central banks string
it out. A deflation in credit, asset prices and economic activity. A deflation
that doesnt need shop prices to fall; its still a deterioration of the monetary
standard , this one characterized by volatility as much as deleveraging, but
also squeezing debtors every time the dollar rises. That in turn is squeezing
creditors, of course, now terrified of default and write-downs but so far spared
the actual pain. The worst of all possible worlds results. No new investment
because lenders wont lend and debtors wont borrow. No write-down or write-off of
existing debt, lugging a permanent drag onto economic activity. And in the
meantime, the dollar remains money the world over, proving last decades
Cassandras early, wrong or just stupid. Click to Enlarge Call me all three if
you like; the last thing the world wanted pre-2007 or today is a rising dollar.
Not the U.S., China, Europe or anyone else. So just to mess with the most people
the most, thats what we keep getting. But only in fits and starts. Which like
the wonderful nothing achieved by zero interest rates, might just be the very
worst we could ask. Plenty of chart analysts and media hacks will tell you today
that the price of gold just broke below its 200-day moving average . The smarter
ones will add that it fell through the uptrend starting with the great deflation
of Lehmans collapse, too. But only in U.S. dollar terms, we note here at
BullionVault . Look at gold ex-dollar as our bright orange line does above. The
dollar devaluation, forced through by Ben Bernanke cutting in line and slashing
rates faster than anyone else in 2007-08, worked such magic that non-dollar
investors are now to date wearing a much shallower top-and-drop pattern in
gold so far. This might matter. Because gold has outperformed all other assets
(and very nearly all mutual and hedge funds too) since the eve of this crisis.
Most people thank the inflationary response of central banks everywhere. A
handful think golds rise might instead be due to bullion offering the perfect
deflation escape a route to extricating yourself from the debtor/creditor
relationship underpinning the vast bulk of alternative homes for your savings.
Either way, a dollar rally is rarely good for the price of gold. And no one,
least of all the Bernanke Fed, wants to allow a persistent dollar rally on their
watch, either. Report courtesy of BullionVault s Adrian Ash.
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