French peasants and Indian housewives have traditionally avoided stocks, bonds and even bank deposits in their investment portfolio, preferring instead to put their faith in gold, whether in bars, coins or jewelry. Every now and then, usually when the world economy is going through a difficult phase, there comes a time when the French peasants turn out to be right, and gold outperforms all other assets. The 1970’s were the last such time; the years ahead may well be another.
Recommending gold is not directly correlated with bearishness. A year ago, and at the beginning of this year, I was extremely bearish on the stock market, and rightly so, at least in the short term, but I was not particularly bullish on gold, because it appeared that the U.S. and other world economies were in for a deflationary rather than an inflationary recession, the 1930’s rather than the 1970’s. Since then, however, Fed Chairman Alan Greenspan’s interest rate cuts have stimulated the United States and indirectly the world economy, at a cost of threatening to re-ignite inflation.
This is not to say that the last six weeks have been good ones for us Bears; indeed the evil (or at least the overvalued) have been flourishing like a green bay tree. Cisco, for example, always a favorite Bear counter, is up 72 percent from its April low in spite of the company having lost more in the last quarter than it made in the previous year. However, a number of factors indicate that the Bull triumph may be short lived, and when the Bear supremacy resumes, it is likely to do so in a different way from that prevailing in the six months to the end of March.
First, and most important, Greenspan has continued to increase the money supply at a rate that is unsustainable without causing inflation to reappear. Earlier this year, I wrote “unsustainable over more than the short term,” but this is now no longer the short term; the M3 money supply has been increasing at an annual rate of more than 14 percent for six months. As far as money supply growth is concerned, we are thus entering the medium term, and can expect inflation to reappear in considerable force later in the summer. At first, of course, the inflation is likely to be directed at stock prices and house prices (which have been stimulated into frenzy by five short-term rate cuts operating on a market that, on the two coasts, was already overheated.) Then, it will begin to appear in the consumer price index, but probably initially in the form of increases in energy prices, which will be put down to OPEC greed or California fecklessness. By September or October, however, it should be becoming clear that the rate of inflation is no longer confined to the friendly 3-4 percent range in which it has spent the 1990’s, but is headed for the high single digits or even the low double digits.
Second, the U.S. recession has not gone away, and is likely to deepen as the decline in business investment following the dot-com boom take their effect. The trade deficit for March widened again from the freakishly low February level. Thus the first-quarter gross domestic product figure, due out in revised form Friday, is likely to be revised substantially downwards from the initial estimate of 2 percent growth, which assumed February’s better trade figures continued in March. Unemployment has continued to rise, and the rate of layoffs is substantially above that prevailing at the beginning of the year. Consumer spending continues strong, but it is simply not possible for the consumer to sustain the economy single-handed while the rest of the economy declines around him. Without production and income rising, consumer spending just increases consumer debt, already at record highs and increasing rapidly.
Nevertheless, with stock prices back near their 2000 highs, at least as measured on the Dow index, and house prices booming, the danger of a deflationary spiral along the lines of the 1930’s or the Japanese 1990’s seems to be receding. To the extent that there is an artificial barrier caused by interest rates’ inability to go below zero percent in nominal terms, this is of course something to be welcomed. As the 1938 pop song went after the Munich crisis, “Thank you, Mr. Chamberlain.” Or, in this case, “Thank you, Mr. Greenspan.” As after Munich, however, it is unlikely that the thanks will be so heartfelt in a year’s time.
For it is not to be supposed that just because the 1970’s were not as painful as the 1930’s, Greenspan has achieved something positive by moving us from a ’30s rerun to a ’70s rerun. It is difficult to imagine any recession, even if it lasts a decade, being as bad as the 1930’s, if only because we will presumably, deo volente, be smart enough this time around to avoid rampant protectionism and the outbreak of a major war. Conversely, it is very easy to imagine a re-run of the ’70s, a decade of economic stagflation, ugly clothes and unpleasant music, being even worse than the original (well, maybe not in the case of the clothes and the music!)
While inflation seems likely at present to remain below double digits, the valuation excesses now, both in the stock market and in terms of purchasing power, in the bi-coastal housing market, are much greater this time around than they were in 1972-1973. Greenspan’s monetary loosening has done nothing to correct the valuation problem, indeed it has only prolonged the period of pain needed to correct it and broadened the problem to include housing as well as stocks. Hence the negative “wealth effect” from the inevitable collapse in valuations is likely to be greater than it would have been, approaching the 200 percent of GDP by which Japanese wealth declined in the 1990’s.
Which brings us back to gold. The great period for gold aficionados, was 1971 to 1980, during which it went from an official price of $35 (at which ownership was prohibited, but even the free market price was below $50) to a peak of $800 an ounce. A week ago, at $270 an ounce, gold was in terms of January 1971 U.S. purchasing power at a price of $60.71, not far above its artificially restrained 1971 level. In terms of April 1980 purchasing power, it was at a price of $123.63, less than one sixth of its 1980 peak.
If we are to repeat the 1970’s economically, it seems more than likely that we will repeat it in the gold market. After all, there have been no great gold mine discoveries in the last three decades, and the period of low and declining prices since 1980 has seen a closure of many gold producers, and an exhaustion of existing mines. Improved technology has allowed gold production to double since 1980, to a level of 2,300 tonnes per annum, but this output has a value of less than $20 billion at today’s prices, and of course gross world product in real terms has considerably more than doubled in the same period. Central banks have been selling gold, but their reserves are far less as a percentage of the world gold stock than in 1980, thus their ability to depress the market is also less.
In today’s dollars, 1980’s peak would represent a gold price of $1,747. We are perhaps unlikely to see that, since the gold mania of 1980 seems unlikely to be repeated. Nevertheless, a rise in the gold price to half that level, or $874 in nominal terms, seems quite likely at some point. And, if the 1970’s are to repeat themselves, now may be the point.
The London gold price rose by over $15 Monday. The French peasants seem to be on the move.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.