The joy of gold and silver - stagflation protection
Gold and silver are international cash and will flourish while bond markets may collapse, and will flourish while bank deposits [after bank charges] fail to perform and will rise against all currencies.
Posted: Friday , 25 Mar 2011
When inflation hits a healthy economy such as China it has an entirely different impact than it does on today's developed world. When we hear the word inflation, the mind turns back to textbooks on economic principles and sees solutions that did apply in the past but do not apply today. That is in the developed world. These solutions will work still in China where incomes are soaring, GDP growth is in double figures and money supply needs to expand to accommodate tremendous economic development. In the developed world where inflation has passed the poor levels of economic growth and interest rates, the scene is totally different.
China will overcome rising inflation as those suffering it are seeing their incomes rise rapidly and the impact of inflation negligible. As their costs rise, their income rises faster, leaving little pain. Interest rate rises benefit the vast majority of Chinese, who are by nature savers as they increase income to them. But even they can see that inflation is making a mockery of interest rates returns [after bank charges]. The combination of poorer returns, in the current inflationary environment is beginning to make the Chinese saver realize he is better off with gold than deposits at the bank.
In the developed world the same should hold true. Negligible returns from interest rates, after bank charges, are far below growing inflation levels resulting in a drop in total savings, now needed more than ever to live on. While gold does not give a return it does rise faster than inflation, far faster and reflects unstable economies and uncertainty.
With the benefit of hindsight we can see that gold has multiplied almost five times since the turn of the century, only 10 years plus a little. Savers who went for gold are far richer now than they were then, in real terms.
As to the future, it seems that interest rates will not overtake inflation so ensuring that bank deposits returns after bank charges will continue to yield negative returns. If interest rates do rise it is likely that the bond markets will collapse, thus making these forms of [almost] cash, inadequate investments.
Gold is international cash and will flourish while bond markets collapse and will flourish while bank deposits [after bank charges] fail to perform like gold or silver.
Should the economy fail to reach higher levels of growth, equity markets will, at best stall, even if they do not fall. Rising interest rates will bring them down. The prospects in a stagnating inflationary environment will be for gold and silver to rise as they protect wealth, while other markets don't. If as is a most likely prospect currencies tend to weaken, then gold and silver will remain internationally acceptable, while they rise against all currencies.
THE REALITY OF STAGFLATION
To put it in a nutshell stagflation is where economies do not grow or fall, while money cheapens persistently, ensuring no protection against wealth attrition. Investors who wish to guard against this have to flee such environments while they still can. Gold and silver, inside a country suffering stagflation, bring the same benefits as though that wealth were held offshore in nations where the economy is growing interest rates are real and the currency appreciating. The joy of gold and silver is that you do not have to worry about government actions, because they have no government!
In the developed world one sees limp economies, interest rates at such low levels that allow economies to grow very slowly still [raising interest rates would choke off that growth] and rising levels of inflation that are now undermining what little growth there is. Even though these economies are growing, that growth is hormone free and very limp. It does not matter that the inflation rates are low historically, but it does matter that they are reducing economic activity and causing rising resentment. Food and energy inflation are doing the same as raising interest rates would. That kind of global inflation is acting like the imposition of additional taxes, reducing the already low levels of discretionary income. Since 2007 people in the developed world have seen cutbacks in their income or stagnation at best. They have been through a real struggle to pay off debts so their tolerance to a cut in their income again, is dropping fast.
The elderly and retired are living off savings. Inflation reduces the buying power of these funds, persistent inflation impoverishes them. The only beneficiaries of rising and persistent inflation are debtors who see the real value of that debt diminish. People living off the interest on deposits have seen that income decimated with negligible returns on those deposits. Now inflation is eating into what little they get, with little prospect of rising interest rates to compensate. Inflation will gobble up whatever interest they earn anyway as money loses buying power, steadily.
Wage earners are more than likely to see static incomes and feel more job insecurity in the next year or two. Any inflation, even low levels, will just eat away at their income breeding the sort of resentment that creates social unrest in poorer countries. Politicians will be overwhelmed by the temptations to cater to those being hurt by stagflation.
Worse still, rising gasoline prices will result in lower economic activity as they move higher, with oil moving towards the last peak of $150 a barrel if more bad news comes our way. No doubt we will then see another recession.
What has become a real factor in people's perception of the future is the discouragement factor on consumer's perceptions. It causes more saving to be made, more debt to be paid off, more acceptance of harder times, making the consumer pull in his future hopes. Spending then suffers when consumers might well be able to spend more, because they don't want to be caught in the debt trap again.
Have absolutely no doubt that it is a job-secure, house-secure, cash-secure consumer that will be the backbone of a real recovery. Until he is a common sight, any recovery will continue to be limp. If he now has to savor low inflation as well, he will hunker down until the horizon looks far brighter than it does now. The current situation, although not exactly ‘stagflation', feels like it is.
This scene may well persist for a year or two, or more still. Once this ‘tone' of stagflation reaches the political arena, anger will replace hope and social turmoil follow. While some may feel that overall we are seeing a failure of capitalism [except for those in a position to take advantage of it], we are in fact seeing a failure of the global monetary system as described by rising precious metal prices.
THE DOLLAR AND DIMINISHING CREDIBILITY
But the greatest danger is that the buying power of the U.S. dollar and its international value continues to fall, without any effort whatsoever by the U.S. government or Fed to act to improve its value or stop the slide. As a consequence of far greater proportions than low internal inflation will be the rising inflation due to the falling dollar. That will cause a broad rise in prices across the board of imported goods. These are cheaper than home produced ones usually and preferred by cost-conscious consumers.
For so long the U.S. monetary authorities have been mesmerized by their internal financial problems that the international consequences of their actions have been ignored. The falling dollar and its lessening role as a global reserve currency will shortly deliver the consequences of this myopia. Add these events to the current financial ails and you have a financial situation beyond the power of both the government and the monetary authorities to rectify. It may well be that gold could add lost credibility to creditworthiness and tempt governments to confiscate their citizen's gold and perhaps, eventually, silver.
Stagflation will speed up gold's return to the monetary system.
Julian Phillips is a long term analyst of the global gold and silver markets and is the founder and principal contributor for Global Watch - Gold Forecaster - www.goldforecaster.com and Silver Forecaster - www.silverforecaster.com