On the heels of the recent post-election market turmoil, is the world going to see a global monetary reset with QE used to purchase gold?
(King World News) Paul Brodsky, Macro Allocation Inc. — Gold
To “take a flier” against consensus with long duration treasuries also suggests taking a flier with gold. Treasuries and gold are normally inversely correlated. In a typical economic cycle, declining treasury yields imply dollar strength, which in turn, suggests gold weakness. We argue that current conditions do not imply a normal economic cycle and that, in the current environment, long treasury positions may be best hedged – and potentially enhanced – with a long gold position. (For fixed income investors, this is reminiscent of hedging long MBS positions with long Treasury positions.)…
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In the current environment (imminent balance sheet recession), gold is the most convex asset we know. Gold hedges financial asset values by hedging the currency in which they are denominated. An increase in goods and service inflation reduces the purchasing power value of the currency while an increase in goods and service deflation reduces the supply of goods and services. The former is better understood than the latter because the frequency of inflation is so much greater. At the end of the day, gold is a hedge against balance sheet de-leveraging, whether it comes from a significant increase in the quantity of money or a significant decrease in the value of liabilities. A decrease in the value of treasury bonds, from either debt deflation or currency inflation would send the price of gold in the underlying currency higher.
King World News note: It is very important to understand what Brodsky is saying in the paragraph below about the problem of higher interest rates in relation to investor portfolios and overall consumption.
The Real Problem With Higher Interest Rates
It is true that higher treasury yields would provide investors with positive carry that gold would not (unless investors choose to lend out gold in return for interest). Lost on investors that succumb to this thinking, however, is that with almost $20 trillion of treasury and agency debt outstanding, rising treasury yields would produce more debt deflation on existing portfolios than higher income from newly issued treasuries would stimulate consumption.
You may find the discussion above dense, in large part because gold’s characteristics are unfamiliar to most financial asset investors. After all, it is a shiny rock with no utility or income, a monetary relic of pre- digital generations. The way to think about gold is as a necessary monetary anchor if/when leveraged fiat currencies can no longer be supported by global banking systems and the global productive economy. In extremis, there would be no fiat currency winners, even the dollar.
Simply, gold is the one item against which all currencies, and the assets and liabilities they value, can be re-valued by political and monetary authorities regardless of whether or not authorities coordinate a synchronized revaluation. It is the only politically-unsanctioned potential monetary asset banking systems cannot create and authorities cannot directly control. (Official gold holdings amount to about 22% of above-ground gold.) It is also the only asset on most central bank balance sheets that is not debt. The world’s largest central banks and the IMF continue to store and add to their gold reserves, we surmise, because it might come in handy one day.
The daily price of gold today, in dollars, euros, yen, etc., 1) handicaps the likelihood of the global monetary system failing; and 2) implicitly speculates an exchange rate against which fiat currencies would be converted if necessary.
A Global Monetary Reset With QE Used To Purchase Gold?
Were gold to again become a sanctioned monetary asset, the transformation would likely be executed by the political dimension through their banking systems, as it always has been. We would speculate that such a transformation, if necessary, would be coordinated by the G10, agreed upon through a treaty, and overseen by the IMF and BIS. It would be a one-time monetary reset, rather than a reversion of the global monetary system to a fixed-exchange rate system.
Devaluing currencies to gold would be an expedient political solution to a global balance sheet recession. The reset would be similar in nature to debt jubilees periodically necessary since ancient times. The only difference here would be legal debt covenants would not have to be destroyed. Rather, the burden of servicing and repaying outstanding debt would be greatly reduced through inflation. The inflation would come from extreme central bank money creation used to purchase gold at higher prices – QE for gold. The new money would add a couple zeros to assets while keeping the principal value of liabilities constant.
A monetary reset that ties currencies to gold would not alter commerce. Consumers would not need gold in their pockets. Producers and merchants would be ostensibly satisfied that the debit cards consumers carry are backed by currency tied, even temporarily, to something finite.
Owning Gold Is Not Just About A Monetary Reset
Investors should not necessarily own gold today in anticipation of a global monetary reset. Circling back to a contemporary discussion of whether to own gold in concert with long duration treasuries and other financial assets, the increasing potential for fiscal stimulation through deficit spending increases the odds that already indebted currencies will be rejected by goods and service suppliers. Gold priced in fiat currencies could rise if those currencies do not produce an equal amount of revenue and income. In short, gold should re-price higher if/when global GDP falls and global liabilities don’t.
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