"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Thursday, October 14, 2010

Trial Balloon, Market Manipulation, or Misguided Economics?

Edwin Truman, a Senior Fellow at the extremely influential Peterson Institute for International Economics in Washington, wrote an editorial yesterday for the Financial Times (link).  In it, he exhorts the US to open its vaults and sell its gold.

So what is this really about?  Does he really believe that the US's massive debt load can be handled by the current price of gold?  That's laughable.  There's more to it.  On King World News' blog, James Rickards writes an excellent analysis.  If anything, please read his conclusion in the last paragraph (emphasis mine):
A Message to Garcia
October 13 (King World News) - One of the most famous and widely published essays of all time was A Message to Garcia by E. Hubbard.  Written in 1899, it recounts the effort of the President of the United States to reach out to a foreign insurgent who was incommunicado.  For this mission impossible, the President relied on U.S. Army Lieutenant Andrew S. Rowan who delivered the message against enormous odds but without hesitation and with complete loyalty and devotion to duty.
Lt. Rowan, meet Ted Truman.
Today’s FT carries a column entitled “America should open its vaults and sell gold” by Edwin “Ted” Truman of the Peterson Institute.  Truman’s thesis, in a nutshell, is that the gold price is a bubble and the U.S. Treasury should take advantage of this by selling “high” and using the proceeds to reduce the national debt by about 2.25% of GDP.  Furthermore, the interest savings on the debt reduction would amount to about $15 billion annually thus helping reduce our deficit even more.  And the appeal of Truman’s idea goes even further because the gold sales would give anxious citizens, “…something to hang around their necks…”  How thoughtful.
The intellectual flaws in Truman’s piece are too numerous to review in detail but here are a few highlights: He says that the price action in gold is driven by the “…hype of the bullion dealers (holding large inventories)…”  Really? My wholesale bullion dealer constantly complains about shortages and occasionally puts his best customers on allocation because he’s short of supply.  Truman also says that the market is accompanied by “…the normal amount of fraud and misinformation accompanying asset price bubbles…”.  Apart from a few sleazy coin dealers, the only fraud and misinformation I’ve seen comes from the Treasury and the Fed who refuse to allow a proper audit of official holdings and who cover-up and deny their gold discussions held at BIS and other nearly impenetrable venues.  More to the point, the price action does not reveal a bubble in gold, it shows the collapse of the paper dollar.  The issue here is understanding the importance of thenumerarie or unit of account.  If you make the dollar the numerarie, and think in terms of “dollars per ounce” then the price action may look to some like a bubble.  But if you make gold the numerarie and think about how many ounces your get for a single dollar (now about 0.00075; was 0.00400 in 1999) you can see that the real problem is the dollar is rapidly shrinking to a vanishing point.
Truman’s idea that gold sales and debt reduction would reduce U.S. interest expense by $15 billion per year is the kind of nonsense one gets from static, linear analysis.  In dynamic, nonlinear analysis, such gold sales would so undermine confidence in the dollar as to cause a skyrocketing of interest rates and an explosion of the U.S. deficit easily submerging the savings that Truman posits.  Truman says that the gold standard was associated with “…unstable, prices, output and employment…”.  If by unstable, he means cyclical, yes that’s true (and necessary) but gold was also associated with some of the longest and strongest periods of sustained real growth in U.S. history from 1865 to 1912 until gold’s function was derailed by the creation of the Fed in 1913.  Truman says the U.S. “…has been sitting on [gold] since the Great Depression, receiving no return…”  Actually, gold went from $20.67 per ounce to $1,350 per ounce in that time period; seems like a 6,500% return to me.
Truman says that the gold standard “…has not existed for a century…”.    This is highly revealing. In fact, the U.S. went off domestic gold convertibility 76 years ago, within living memory to many, and only went off international gold convertibility 39 years ago.  But if Truman dates the end of the gold standard not from 1971 or 1933 but from the creation of the Fed in 1913 then he’s right; it has been a century.  That tells you something about how establishment intellectuals like Truman view the real purpose of the Fed regardless of the existence of any formal systemic role for gold.  Nevertheless, gold is not quite the musty relic Truman would like it to be although it is true that an entire generation of finance scholars have come of age since 1971 with no formal analytic training in gold.
We could go on but you get the point.  No amount of analysis will reach the right conclusion if you get the paradigm wrong.  Truman’s paradigm is anchored in a perpetually sound fiat dollar and he is intellectually unable to see the world any other way.  Sadly, he’s not alone.
This leads me to Truman’s most revealing remark of all.  He writes, “Official discussions of the reform of the international monetary system do not include any advocates of a return to gold…” (emphasis added).  The problem with this observation is that he is almost certainly right.  And this is scary.  I have maintained for some time that the return to gold is inevitable and the only issue is whether it would happen through a rigorous and studied process led by the United States or by a chaotic process in which the United States is caught off guard to its disadvantage.  Learning from an insider like Truman that none of the power elite are thinking seriously about gold increases the odds that the dollar dénouement will be chaotic not orderly. 
The reaction of the gold community and various bloggers to Truman’s op-ed was swift and predictable.  He was ridiculed as espousing the “dumbest idea we have ever heard” by zerohedge.com.  Others were simply incredulous and assumed that Truman must have wandered onto the FT op-ed pages after decades alone on a deserted island.  While I might not disagree with zerohedge, there is one problem with this response.  Ted Truman is not a nobody.  He’s one of the most seasoned, experienced and highly respected international monetary experts in the world. His academic, government, scholarly and think-tank credentials are nonpareil.  He speaks to finance ministers, sovereign wealth funds, IMF officials, and Wall Street CEO’s on a daily basis.  Importantly, he was a staff economist to the FOMC.  I have personally worked with many of his colleagues at the Peterson Institute on matters relating to international finance and national security and they are uniformly of the highest intellectual calibre and operate with a truly warm and collegial demeanor.
And that is the point.  Ted Truman is not a fringe figure or a minor intellectual; he is a giant in the field.  He is not just close to the establishment.  He is the establishment.  An op-ed by Truman appearing one day after the IMF semi-annual meeting ended with no effective solutions on the currency wars is no coincidence.  It is a metaphorical Message to Garcia, to the gold insurgents, from the President and the powers that be.  It is price suppression without having to engage in actual sales.  It is a warning to gold bugs that they may get crushed.  It is meant to induce fear into those newly interested in gold that it’s a rough game with no holds barred.  It is a show of bravado by the fiat money crowd.  But it is also a sign of desperation; the last gasp of the ancien régime of fiat money.  If a smart guy like Ted Truman is reduced to the old canard about gold being good only for hanging around your neck, then what else is there to say? The intellectual opponents of gold are now as exhausted as the mines.
Misthos here.  So what did gold do today?  Looks like another record.  It seems to me that gold is a steamroller that not even Sovereigns can stop.  And if this can't stop gold, can a paper debt backed SDR become the next world reserve currency?  I don't think so.



No comments: