gold

The Danger of Irreversible Decisions

A decade ago, the economy was hot and Gold was a hedge against inflation. Gold prices went up. Then the economy tanked, and Gold was a safe harbor against collapse. Gold prices went up even more. Then the Fed instated QE123, and Gold prices went up yet again because the government was printing so much money.

Gold: It’s the one-way trade that never fails!

Until it’s not.

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As humans, we seek a reality that matches our expectations. We want to be right, we like to feel smart. Changing your mind is one of the most difficult things we do. It is far easier to fool yourself into believing a falsehood than admit a mistake. Start with an answer and then find data to back it up.

That’s why some people exclusively get their information from Fox News, while others read Huffington Post and BuzzFeed. Conservatives who watch The Colbert Report claim that Colbert is serious, and only pretends to be joking, not the other way around.

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Ask yourself, “What would make me reverse this decision? What facts or situations or new information would make me change my views or close my position or quit my current goal?”

There should be a long list of technical and fundamental answers. Every decision, no matter how compelling the underlying story, should have an exit strategy. This is especially true of choices that involve a huge emotional investment and an unhealthy reliance on narrative.

If there is no conceivable set of circumstances that would get you to cut your losses, you have a huge, devastating flaw in your approach to decision-making.

See Also:
Confirmation Bias

The Next Golden State

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Two years ago, the Economist featured a cover story touting Australia as The Next Golden State. Perfect weather, beautiful beaches, and prolific government investments in higher education in hopes of building a technology hotbed to rival the one in the original Golden State.

Things were looking great. The commodities supercycle was going to drive economic growth FOREVER. Lucrative mining jobs brought an influx of immigrants – today, over a quarter of the population were born abroad.

Wages increased. Well, some did. Those employed in mining could earn salaries of over $200k with little training or education. For those outside the mining sector, wages were shit. People flocked to mining-related jobs.

The rapid population growth led to a housing shortage. Australia’s major cities did not have the infrastructure to support such quick expansion. By 2011, the rate of homelessness increased to 1 in 200, more than double the rate in the US. Many of the homeless were employed full time.

Good thing they were saving money by forgoing rent. The massive immigration fueled high income elasticity. The cost of living exploded. Sydney is now the third-most expensive city in the world.

Between 2009 and 2011, the Aussie dollar appreciated 43% against the USD. Tourism suffered. Manufacturers couldn’t find markets for their exports. Plants shut down, and their employees moved to support the mining industry. It was a classic case of Dutch disease.

Australia GDP contributions

Now the commodities boom is over. The mining industry will shrink, and unemployment will rise. The country will need to rebuild its non-mining sectors. The AUD will fall, whether by tracking gold prices or through RBA monetary policies.

Dreams of building a Silicon Valley down under may be dashed. Much of the research funding provided to academic institutions came from the mining industry, whether directly or indirectly through tax revenue.

Australia may not become the next Golden State, but at least it can finally go back to being a cheap holiday destination for the rest of us.

Australia Gold Coast

Nothing Gold Can Stay

After more than four years of quantitative easing in the United States, the inflation rate as measured by the consumer price index is just 2%. (According to other measures, it may be even lower.) And XAU is tanking.

What happened to the trillions of dollars in global liquidity injected by central banks across the world? Where is the hyperinflation?

Printing Money

Under Quantitative Easing, the Fed buys Treasury Notes or Mortgage-backed securities for bank reserves in the private sector. This changes the composition of private sector financial assets (swapping low-interest T-bonds for even-lower-interest reserves) but does not add to the supply of private-bank issued money [1].

The private sector will not be able to access more capital, nor does QE necessarily lead to more lending. It just lowers interest rates and makes riskier assets more attractive.

On the other hand, government bond sales and deficit spending result in the creation of a net financial asset.

Unlike a private loan issuance, which creates both a private sector liability and an asset, government deficit spending results in no corresponding private sector liability (the US Treasury will never default), only a private sector asset (the government bond).

Just how much money has been created ex nihilo? A lot.

Hyperinflation

It won’t happen as a result of Quantitative Easing or Deficit Spending.

Hyperinflation is caused by the complete rejection of a nation’s money. Throughout history, hyperinflations have tended to occur not because the money supply expands, but because of unusual exogenous factors such as a decline in production, corruption, regime changes, ceding of monetary sovereignty or loss of a war [2].

Gold has done very well when denominated in Zimbabwean Dollars
Gold has done very well when denominated in Zimbabwean Dollars

So Where Did the Money Go?

Probably the bond market.

The Price of Gold

Nobody knows. What are you going to look at, cash flow and earnings?

Central banks control most of the gold in the world and have been net buyers since 2008. Right now rumor has it that Cyprus may sell gold to fund its bailout, but their €400m sale is nothing compared to what Paulson might be holding.

The Value of Fiat Money

Fiat money has acceptance value because the government and people deem it as an accepted medium of exchange. It has no intrinsic value. But you know what else has no intrinsic value? Gold. Oh, and Bitcoin.

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See Also:

1. Understanding the Modern Monetary System –PragCap via SSRN

2. Hyperinflations, Hysteria, and False Memories –GMO

3. 12 Rules of Goldbuggery — When we have a red hot economy, Gold is your hedge against inflation. When we have a bad economy, Gold is a safe harbor against collapse. It is a one way trade that never fails!

4. The death of inflation –The Economist