Have you ever wondered why we spend hours typing on a totally counter intuitive keyboard layout? Inertia. This layout dates from the development of the mechanical typewriter in the nineteenth century and was specifically designed to avoid jamming by placing the most frequently used letter pairs in a way that it would be hard to type them rapidly. Another reason was to place all the letter of the word “typewriter” on the top row so that the salesmen could show off without knowing how to type. Two centuries later we are still using this same uncomfortable layout although jamming is clearly impossible with keyboards. The costs of changing the layout are ridiculously cheap and yet inertia has kept us from making this easy change that would offer clear benefits for all.
If inertia has kept us from doing this costless and easy technological change what should we expect from 16 European governments stuck in a monetary system that is clearly not working? More inertia. It is only when backed against a wall by mounting systemic risk that the decision to completely rethink the monetary union will be forced upon the member countries. Until then, the Euro will continue to weaken and the divergence in economic performance and financial accounts will only accentuate. In the US and even more so in Europe, fiscal austerity and tax increases have become the motto of governments. Who would blame a government who wants to reduce its debt? It makes for reassuring headlines stamped with responsibility. But as we know (see my pevious article https://seekingalpha.com/article/213198-imf-report-simple-accounting-identities-flawed-austerity), to avoid contracting economies and deflation, any government savings must be accompanied by either private sector spending or current account surpluses.
So why my interest in Gold? It is clearly not because I expect a burst of inflation. If anything, the past few centuries have showed how unreliable gold has been as a long-term store of wealth. Had you bought gold in 1980 and held it the following twenty years you would have lost close to 10% on an annualized real basis. Had you invested in the Dow Jones instead, well let’s just say that the irony is that both gold and the Dow were trading at about 850 at the time. Even if your ancestors had successfully stored it for future generations since 1500, you would have found yourself five hundred years later with a depressing 90% real wealth loss. Another gold bug argument for holding gold is that it makes for a perfect currency, a standard of value. I see it more as a meaningless chemical element that has caused much suffering and the spill of so much blood across the history of mankind, an inexplicable obsession. Those wishing that we return to a gold standard should be reminded just how unstable and dysfunctional the global financial system may be when it is arbitrarily determined by the supplies of a metal whose major sources are located in Russia and South Africa. History is crowded with examples demonstrating how painful the adjustments imposed on countries were under the gold standard.
Ironically, it is precisely because the gold standard is so imperfect that I am recommending gold today. The euro, which is a de facto gold standard for euro zone members, is the latest example of the hardship imposed on countries with no currency sovereignty and which are forced to choose between sensible domestic policies and the urge to correct external imbalances. It has ensured that the euro zone may not run large fiscal imbalances. This loss of sovereignty is the Damocles sword on the head of European countries which will ultimately force the weakest into a succession of debt restructurings. As the imbalances across the different member countries grow larger, the Euro will reflect the mounting stress it has imposed on itself. Finally, like all currencies before it under a gold standard, it will be forced to devalue. Of course, the euro is not really backed by gold but I see gold as a measure of systemic risk.
It measures the level of confidence investors have in governments and the financial system. Similar to volatility, it measures the level of uncertainty. Gold is attractive when most other assets are unattractive. At a time when government’s solvability is questioned and currencies will have to bear the weight of adjustment, gold is an attractive tail hedge. The metal will benefit from the diversification that Europeans will actively seek for as the net closes around them and provide an interesting tool to benefit from rising European sovereign credit spreads without taking on the counterparty risk inherent in derivatives.
The most powerful and misunderstood bull market today is politics. This political bull market is planting the seeds for profound changes in long term policies and will be reflected by a large increase in market volatility for as long as the markets fail to understand the unintended consequences of these tectonic changes. Think of it, this is the largest build up in government debt since World War II and this is the largest economic contraction since the Great Depression. The policy that has shaped our world economies between these two major events is Bretton Woods. T
he latest gold bubble in the 1970’s, which pushed gold up 14 fold, was attributed to the collapse of the Bretton Woods system. As mentioned previously (https://seekingalpha.com/article/214608-bretton-woods-inertia-and-the-coming-end-of-an-era
), I tend to disagree and believe that the tipping point for the Bretton Woods system has just been reached and with it the end of an era. If so, imagination could well be the only limit to this gold bubble and a unit invested in Gold in Euros makes sense.