A New Era of Money
We left off yesterday thinking about the dual nature of gold – a reflection made more urgent by the Fed’s action yesterday.
Gold’s schizophrenia frustrates gold bugs, economists and central bankers. If it is a commodity, it goes down as ‘money’ becomes dearer. If it is money, it goes up. Which is it?
By October of 1979, in the Post-Nixonian era of inflation, consumer prices were rising in the U.S. at the rate of 12% per year. Gold had risen too – to $500. It is almost inconceivable to us now, but comedienne Bette Midler made news when she asked to be paid in South African gold coins rather than U.S. dollars.
In January of the following year – on the first two business days of the year, exactly 20 years ago – gold reacted in a big way. It rose $110 an ounce to $634. Central bankers began to wonder if gold should be returned to its role as the foundation of the world financial system. U.S. Treasury Secretary G. William Miller announced that the U.S. would hold no more auctions of its gold. “At the moment,” he told the press, “it doesn’t seem an appropriate time…”
Thirty minutes later, the price of gold had risen $30 to $715 an ounce. The day after, it rose to $760. And finally, on the 21st of January, two decades ago, gold hit its record high of $850 per ounce.
Was gold reacting as a commodity? Or as money?
In the 12 years leading up to January 1980, gold had risen at an average annual rate of 30% per year. But the inflation rate was only an average of 7.5% during that period. The 12-year return on gold exceeded the return on stocks in any 12-year period in history. And at that end of it, there was more money invested in gold than in the entire U.S. stock market.
By 1980, many investors were convinced that gold was the only true money and that it would go up forever. “Gold is indestructible,” they would say. “Gold is forever,” they chorused. “Remember the golden rule,” they chided: “He who has the gold, rules!”
And so, they bought gold…and have regretted it for the last 20 years.
Not that there weren’t many episodes during those 20 years that gave cause for hope. The dollar crash of ’85…the crash on Wall Street of ’87, the Gulf War…the LTCM crisis…the Asian currency crisis…
“In 1998 the world was suffering a deflationary collapse,” Porter Stansberry writes, embellishing his ‘gold-is-no- longer-money’ argument. “Prices collapsed for commodities, prompting credit defaults. We’d seen this happen many times before in history. But the difference this time was the Fed stepped up to the plate and eased the crisis. And yes…I know that in the long run this will have consequences… resources that should have been forced into bankruptcy will continue to produce marginal products, making it difficult for new, more efficient producers to survive. See Japan for the last 10 years.”
“But the question remains,” Porter continues, “if the Fed is able to produce liquidity…how can the world spiral into a deflationary crisis? It would seem to me that the real risk will always be an inflationary crisis because this is something that the Fed cannot immediately solve.”
Porter’s view is probably the dominant one. The Fed can ‘immediately solve’ a deflationary crisis. How? By increasing the money supply. That is what the Fed began to do yesterday.
If it succeeds, there will be no need to remove the cobwebs on gold supplies. Stock prices may continue to rise on Wall Street…the dollar may recover…and gold can rest disturbed. As Floyd Norris put it in a headline from the N.Y. Times, May 1999, “Who Needs Gold When We Have Greenspan?”
Ah, how nice it is to live in this New Era – when the fears, mistakes, and buffooneries that have plagued mankind for so many centuries have finally been eliminated. It was only 2 decades ago that investors thought the dollar was finished. Now, we see that it is gold that is finished, because the Fed can ‘immediately solve’ a deflationary collapse.
And inflation? Paul Volcker showed us how to beat that. Volcker cut off liquidity – bond yields soared to 18%…and inflation was finished. The day after gold hit its $850 high, it plummeted $145…and now stands, nearly a generation later, at $269 per ounce.
Is gold washed up? Maybe not. “Gold will be part of the international monetary system in the 21st century,” predicted economist Robert Mundell in March of 1997. Then, accepting his Nobel Prize a year ago: “The main thing we miss today is universal money, a standard of value, the link between the past and the future and the cement linking remote parts of the human race to one another…The absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in several thousand years…”
Have Richard Nixon and Alan Greenspan created a permanent New Era in monetary history? Or just a temporary one?
We will see, dear reader, soon.
January 4, 2001
*** The Committee to Save the World went into special session yesterday – and decided to act. Specifically, Alan Greenspan exercised his put option.
*** In a surprise move, the Fed cut its Fed Funds rate by half a percent. The announcement was made during business hours – which caused a wave of panic buying on Wall Street.
*** The Nasdaq rose 18%, 325 points. The Nasdaq 100 drove even higher – up 19%. Record increases for both.
*** The Dow rose almost as much – up 306 points. GE, for example, a stock destined for big losses – rose 9%.
*** Why did the Fed act? Because economic conditions seemed to be deteriorating more rapidly than expected. December’s manufacturing figures dropped to their lowest levels since ’91. The National Purchasing Managers index dropped for the 5th month in a row. Auto sales by U.S. automakers fell 15% in December.
*** Reuters reports that both delinquency and foreclosure rates on residential mortgages are rising. More than 4% of residential loans are now delinquent.
*** “Holiday Season Chills Retailers,” announced a headline from the Atlanta newspaper. Even Wal-Mart shivered as sales figures failed to reach its 3% to 5% growth targets.
*** And then, of course, there was Wall Street. Last year was disastrous for many investors. And Wall Street’s big brokerages and investment banks would like nothing better than to see a vigorous upward move in stocks to start the New Year off. Yet, the first day of trading was disappointing. And yesterday began poorly, too – with bond yields and stocks falling.
*** But after the Fed’s announcement, of course, it was a whole new ball game. The Internet sector hit a home run – up 21% for the day. And the Big Techs got a much-needed hit or two – with Cisco, for example, up 24%, to $41.
*** Three times as many stocks rose as fell on the NYSE. More than 10 times as many hit new highs as hit new lows.
*** But by the close of trading, the panic seemed to be subsiding. Inktomi, a software company, announced weaker- than-expected sales and its shares slumped 23% in after- hours trading.
*** Still, the Fed action looks like a big success. The shorts were caught; many were surely wiped out. And the dreamers and schemers were given cause to suit up, get out their gloves and get back in the game.
*** With a little luck, the rally will continue for a few weeks. Who knows, maybe the Dow and Nasdaq will be driven back near last year’s highs. But it is unlikely.
*** “Rate cuts are not a panacea,” comments the Prudent Bear’s Lance Lewis by way of the Daily Reckoning web site. “Rate cuts will not make all the bad debts of bankrupt Internet and telecom companies good. Rate cuts will not bring back the millions of brokerage accounts that have declined 50 to 100 percent over the last year as the stock bubble collapsed. The only thing accomplished here today was a short-term change in psychology that could be very short term indeed. This was clearly a panic move on the part of Uncle Al, and there are already nervous rumblings among market participants that it was just that.”
*** The big risk is that the rally will peter out and stocks will fall. Then, the last fantasy of the New Era will be extinguished. When investors realize that Mr. Greenspan and the Committee to Save the World have lost their magic, the way will be cleared for another major move to the downside. More below…
*** Oil rose 79 cents yesterday. Gold lost 70 cents, falling to $269.
*** The dollar recovered some of the ground it had lost to the euro. March euro contracts had the currency at 93 cents.
*** “The New Economy Was Foolish Optimism” says a headline in the International Herald Tribune. The article, by Robert Samuelson, explains what few seemed to notice at the peak of the bubble – profits matter.
*** Another IHT article – this one by economist Paul Krugman – notes that “2000 was the year when virtual reality – companies without physical assets, without profits, and sometimes without products – lived down to the expectations of the skeptics.” Krugman gives WebMD, formerly Healtheon, as an example. Last year at this time, a single share of the company would have purchased 1.5- megawatt hours of electricity in California at wholesale prices. Today, you would need more than 100 shares.
*** “Ohhh, Monsieur Bonner,” said Mr. Deshais this morning with a very sad look on his face. “Did you see what happened? A fox must have gotten in the poultry yard. He killed a turkey, two chickens and a duck. I thought all the ducks had been carried off, because I saw only the dead one. But then I saw them out on the pond.”
*** There must have been panic in the chicken house. The birds must have felt like short-sellers – trapped, with no way to escape.
Closer inspection revealed that it was probably not a fox at all. The animals had been bitten on their necks and bled – as a weasel might do. None had been eaten.
*** “Well, at least we can still eat them…” said the gardener, later…dipping a dead duck into a vat of boiling water, “and I was going to kill them anyway.” Waste not, want not.