During the first stage in the credit crunch gold was popular with investors. It is not difficult to see why. It has always been seen as a safe haven, and let’s face it, anything relatively safe is greeted with open arms by all investors, as if it was some kind of new Shangri-La.
But it has been argued here that there were other factors driving up the price of gold. For example, its popularity in India as a form of jewellery, and its peculiar properties as a conductor for electricity making it ideal for semi-conductors.
But as the price rose and rose, and anecdotal evidence suggested Indians had as a result turned from buyers to sellers of gold, it seemed the yellow metal had reached top.
But, now there is a view that as the credit crunch deepens gold will come back into fashion again. There are three main, but related, reasons for this:
Firstly, there’s the continuation of fears over inflation – in the past high inflation has spelt high gold. But then, as has been argued here many times, there are good reasons for thinking the current inflation scare might be short-lived.
Secondly, there’s the turmoil in the currency markets. The US and UK are in a right mess, but the Eurozone is in even worse shape, and things are dire in Japan. So, it has been suggested currencies will experience a kind of race to bottom, no one wants to hold any of the major currencies, the result will be a search for an alternative – and that alternative will be gold. Well, that may be true – but then again, this theory overlooks the nature of business cycles. As the economies of the developed world slow, food and oil will fall in price, helping to create the next up-phase in the economic cycle. If the Eurozone recovers, then the race to bottom could change to a race to buy Euros.
Finally, there is something called Fiat money. You may know that banks can create credit. Apologies for those who know this, but here is a brief, but important, digression.
Assume there is only one bank. And this bank knows that at any one time its customers will never want to hold more than 10 per cent of their money in cash. So, assume for a moment, it has £1m deposited in the bank, that’s hard cash. It knows that at any one time customers will never want more than, say, ten per cent of their money as cash to spend. So, in that case, the bank can actually afford to lend out a further £9m. So that in total its customers now have £10m: £1mn in cash, £9mn in debt. They will never want more £1m of this total £10mn as cash. In other words, providing this bank has enough cash to cover customers’ demand for paper money, it can happily lend out more money than it actually has.
But what do we mean by money? If money is the amount that sits in our bank, plus our cash that we can see and touch, then actually this £9m the bank has lent out is new money. By creating credit, the bank has created money.
Now remove the assumption about there only being one bank. Providing all the banks cooperate with each other and there are central banks to smooth out any difficulties that may arise from time to time, then the banking system, by lending out money it doesn’t have, actually creates new money.
Now, in recent years, this system has seen a growing number of critics. They say the whole economy is based on debt, that debt carries an interest rate and that, as a result, we live in a system that is based on very shaky foundations. Furthermore, goes the argument, debt has to carry on rising, just for the system to sustain itself.
It is then argued, only a monetary system that is based on something solid, like gold, can survive in the longer-term, and that is why gold is sure to make a comeback.
This theory, though, is quite dangerous.
For one thing, it seems to have given rise to a rather unpleasant surge in anti-Semitism on some Internet sites as bankers are blamed for our ills.
Secondly, it misses rather an important point. When we borrow money we are in effect hoping to repay this money from an anticipated growth in our future stream of income. Providing the money we borrow is used to help create this extra flow of future income, then the system is sustainable.
So, Farmer Giles expects a new tractor to enable him to grow more corps. The extra money these crops bring in pay for the tractor. That’s why he needs a loan.
And this is the point. Economic growth relies on debt. Karl Marx theorized that without the gold found in the New World, the Industrial Revolution would never have been funded, and so would not have got off the ground. If economic growth is determined by innovation and then investment, then we have no choice but to borrow from future earnings. The economic depression of the 1930s was perhaps caused because our production potential created by the great discoveries of the earlier decades was not matched a rising demand. Back then, more debt was required. That’s what Keynes advocated.
The single biggest threat to the economy today is that we overreact to the credit crunch; that Democrats in the US try to enforce new tariffs, leading to a worldwide trade war; that, somehow, the US blames China for all its ills, and the backlash leads to a downward spiral.
But maybe an even bigger danger is that we turn on the banks, and in the process bite the very hand that could feed the recovery.
It may be that all this talk about gold surging in price is an early sign of this dangerous backlash. But as the central banks are run by savvy individuals such as Ben, Mervyn and Jean-Claude, this will not happen. And be grateful that it won’t.
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