Hold the Frankincense and Myrrh
As we approach the end of the calendar year, it is useful to look back at recent events to give us a sense of what the year ahead may hold in store. Looking back at the past couple of months, two events merit closer examination – the decision by the Bank of Japan on Hallowe’en to engage in unprecedented money creation and the Swiss Gold Initiative referendum held on November 30th.
The bigger story is the one from Japan. On October 31st, the Bank of Japan announced that it would purchase 80 trillion yen of Japanese Government Bonds in the upcoming year using newly printed money. Two aspects of this announcement are of particular interest – the scale and the timing.
First, the scale of the intervention is huge. 80 trillion yen works out to be around 700 billion dollars. This is almost the same size as the US Federal Reserve’s quantitative easing scheme at its height, but considering that the Japanese economy is less than half the size of the American economy, the relative scale is over twice as large (around $5,500 per person!).
According to the Bank of Japan, the policy is intended to break the deflationary mindset that has persisted in Japan since the implosion of the Japanese ‘bubble economy’ in the early 1990s. Deflation, or persistently falling prices, is feared by governments as it makes debts more difficult to repay. Japan’s leaders find deflation particularly terrifying as Japanese government debt is now equal to more than two and a half times GDP, the highest debt burden in the world.
According to Japan’s trading partners, though, this is the first shot in a ‘currency war’ of a kind which has not been seen since the 1930s. Since announcing the policy, the yen has fallen a remarkable 15% against other currencies. This fall in the value of the yen has the effect of making Japanese-made goods less expensive for foreign buyers. Cheaper Toyotas for Europeans and Americans should result in more exports, and consequently more jobs for Japanese autoworkers (but fewer jobs for autoworkers in Volkswagen and GM plants).
However, the fact that the program was announced only days after the U.S. Federal Reserve officially ended its own program of extraordinary money printing (the aforementioned quantitative easing scheme) points to the policy’s true purpose. As in a globalized financial system money created in any one country can easily find its way to any other country, the implication is that the Bank of Japan has taken over the role of providing free money to the world’s financial system from the U.S.
As I have written before (in the column “The Demise of the Dollar” back in May) the U.S. faces a dilemma as the desire to paper over the problems of an insolvent global banking system with money printing directly threatens the status of the U.S. dollar as the global reserve currency.
By convincing the Japanese to take over the job of money printing, though, the Americans have performed a rather neat trick. First, money created by the Bank of Japan and made available at near-zero percent interest will be borrowed by American and European banks in order to keep financial asset prices high and themselves solvent. Second, the 15% fall in the value of the yen can easily be interpreted as a rise in the value of the dollar, which encourages foreign holders of dollars to continue to hold and use them for trade and investment.
However, if two objects are thrown off a ledge at the same time and if one falls faster than the other, while it may appear that one is moving higher relative to the other, the reality is that both objects are moving rapidly towards the pavement. In a similar fashion, if the yen is currently losing value at a faster rate than the dollar the relative strength of the dollar does not negate the fact that both currencies are racing towards zero.
Alarmed by the tendency of politicians and central banks to choose the path of money printing, inflation and currency depreciation as demonstrated by the Bank of Japan, the Swiss held a referendum at the end of November to decide whether the Swiss National Bank should increase gold’s share of central bank assets to 20% (it should be noted that until 1999 the Swiss National Bank held gold reserves equal in value to 40% of the Swiss francs in circulation). As gold cannot be printed by central banks, insisting on gold backing is a way of limiting the ability of central banks to create money (and thereby destroy its value) at will.
Today gold only accounts for about 7% of the assets of the Swiss central bank. The proportion of gold fell rapidly when the Euro had a near-death experience in 2011 that caused Europeans to shift their savings into Swiss francs. The resulting demand for francs drove up its value to the point where Swiss exports were becoming too expensive for customers in the Euro zone. In response, the Swiss printed billions of francs which were used to buy Euros on the foreign exchange market. This exchange of francs for Euros has kept the value of the franc below 83 Euro cents (or, conversely, kept the value of the Euro above 1.2 Swiss francs).
With the policy now entering its 4thyear, though, more and more Swiss are concerned that the value of Switzerland’s growing pile of Euro-denominated reserves will fall if the European Central Bank decides to behave like the Bank of Japan and engage in reckless money printing in order to support the financial sector, stoke inflation and increase export competitiveness.
While the referendum failed, the fact that it was held at all points to a growing awareness that in a world where all central banks are committed to money printing and inflation, all central bank-issued currency is certain to lose value.
Central bankers like to believe that any inflationary tendencies they set in motion can be easily reversed, but history suggests that once inflation gets going it tends to accelerate. People in Japan and Germany and other parts of the world that remember the horror of hyperinflation (where the value of a currency falls to zero) are increasingly buying gold to protect the purchasing power of their savings. Central banks, which since the late 1980s had been net sellers of gold, also began accumulating gold in 2010.
While un-backed paper currencies on average last only about 30 years (which makes our current monetary system an exceptional success as it has been 43 years since Richard Nixon defaulted on the dollar’s gold convertibility in 1971), as we know from the Christmas story gold has been valued as money for thousands of years. While we may no longer have much use for frankincense and myrrh, gold most definitely can help us to preserve our wealth in a world where politicians and central bankers appear united in their determination to destroy the purchasing power of the world’s paper currencies.
As the hedge fund manager Kyle Bass put it recently:
"Buying gold is just buying a put against the idiocy of the political cycle. It's that simple."