Bill Emmott - International Author & Adviser


The end of the golden age will soon be with us
The Times - April 25th 2011

Gold always seems designed to catch the eye, whether on a Middle East potentate’s bath taps, a soon-to-be princess’s tiara or as the price passes $1,500 an ounce at the same time as the Standard & Poor’s credit rating agency fires a warning shot across America’s debt-laden bows. Since we in the West also like to believe that everything is still about us, it is natural that gold’s rise in value has been seen as a declaration of doubt in the dollar, in European sovereign debt and in western leadership more generally. But is it right?

            In truth, the yellow metal is an inscrutable thing, a sort of reductio ad absurdum of pundits’ general difficulty in explaining rises or falls in the prices of most financial instruments. The price goes up because more money is bid to buy it, and sellers and buyers are thereby matched again. Yet the reasons being given for why more money is being bid for gold don’t really add up.

            Traditionally, inflation is the reason offered, and it is true that thanks to oil and other commodity prices, inflation has been on the rise worldwide during the past year. But it is hardly at spectacularly scary levels, especially in the country focused on last week by S&P and thus by the latest gold pundits: at 2.7% in America in March we are not exactly seeing the currency being debased by runaway inflation. Unlike in the 1970s, the last time when inflation sent gold soaring, western economies do not have the rigid labour markets and strong trade unions that can create a real wage-price spiral.

            The dollar has, admittedly, been falling in value recently, but then that means other currencies—the euro, Swiss Francs, sterling, the yen—have been rising. So a second argument of the gold bugs, that the rising price reflects a general disillusionment with paper currencies, doesn’t ring true either.

            To believe that, you have to believe that governments are going to stir up inflation deliberately in order to erode the value of their debts, of which devilish intention there is no obvious sign—nor, unless central banks’ independence is removed, any real chance. The European Central Bank’s haste to raise its interest rates points the other way, as do signals from the American Federal Reserve that its “quantitative easing” (ie, printing money to reflate the economy) is coming to an end.

            In fact, if the interest-rate cycle really is turning, and will soon bring an end to the current period of virtually nil returns on money, it ought actually to be bad for gold. One plausible explanation for gold’s rise has been that its normal disadvantage, that it provides no interest income or dividend, disappeared when interest rates fell nearly to zero. As soon as they rise, that disadvantage will return—unless they are rising because of a genuine fear of inflation.

            The trouble with gold is that, just like paper currencies, it has no intrinsic value. Supply is limited, but so is ultimate, end-user demand for anything other than investment, and gold can always be recycled. Its strengths are that, unlike paper currencies, it cannot be debased by politicians, and that it is anonymous unlike shares or bonds, and that it is readily saleable. That makes it popular with the sort of Tea Party supporters who favour a cabin in the woods and a pick-up with a rifle-rack behind the driver’s seat, with those fleeing collapsing dictatorships, and those expecting inflation.

            Apart from the Sarah Palin thinkalikes, that does not really describe either America or Europe. Both continents have big problems, but if the debts really go wrong, the result is far more likely to be deflation, Japanese-style, than hyper-inflation, Argentine-style. No, for an explanation of gold’s continued rise to record levels it is better to look elsewhere: to the Middle East, China and India. Not every trend in the world is set in Washington.

            With war and insurrection still spreading across North Africa and the Middle East, and with Syria the latest to see blood in the streets, it would be natural for anyone in that region holding local-currency assets to be seeking to switch them into something more liquid and less easy to confiscate. In other words gold, or indeed silver (while gold has risen more than 30% in the past year, silver has risen by 150%). Since there is no sign of an end to the Arab revolt, this political factor can be expected to last.

            It is in China and India that real concern about inflation can be found, but also a reason why a turning point could be near. In neither of those countries is there anything deserving of the prefix hyper: in China the latest rate of consumer-price inflation was 5.4% and in India 8.8%. But in China the figure keeps on creeping upwards despite tightening controls on credit, and in India it is staying stubbornly high, despite several rounds of interest-rate increases by the Reserve Bank of India. Other emerging economies are also showing worrying rates of inflation.

            Then there is the rather important fact that China’s foreign-exchange reserves, used to prevent its currency from rising in value, have just passed the eye-popping level of $3 trillion, and that within the undisclosed range of assets featured in those reserves, gold is said to be taking a bigger share than before. Meanwhile, last week another credit-rating agency, Fitch, sent a warning shot across China’s non-debt-laden bows, threatening to becoming the first such agency to cut China’s credit rating since 1999.

            Fitch says it is worried about Chinese banks’ exposure to what would become dud loans if property markets there were to collapse. The Chinese authorities are more worried about a truck-drivers’ strike that has shut down the country’s largest port, near Shanghai: the drivers are protesting about rising fuel costs and port charges—in other words, inflation. That strike may well be settled with concessions, but the worry will be that the protest habit could spread.          

            So here is a safe prediction: the countries where inflation is high and really matters, China and India, are both going to try even harder to get it back under control. In both countries it is not just economically undesirable but is also politically dangerous. One way or another, credit growth will be clamped down upon and economic expansion is likely to slow. Of course, the way the West would like China to clamp down on inflation is by revaluing or even floating its currency, the Renminbi, though the Chinese have long made it clear that they prefer gradualism to such dramatic moves as a currency reform.

            If that were to happen, however, it would leave gold with just one argument in its favour—political instability in the Middle East. All the rest would fall away: inflation would slow; a new paper reserve currency as an alternative to the dollar, the Renminbi, would be born; and western economies would be back to fighting off deflation, not rising prices. Even the demand for gold bath taps might well fall.



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