Obligation to Perform
At economic, monetary and fiscal extremes like the present, there is little or no remaining flexibility in the global system. When or if gold and oil prices break out to highs beyond present levels, little credibility will remain for hopes of a sustained, robust and non-inflationary global economic recovery. At such times, waves of change overwhelm and replace previous models, structures or cycles. For the present and massive Keynesian-type attempts to revive global economic growth, because only the short-term matters, dixit Keynes, this must produce results in the short-term. This urgent need to perform can be analyzed and quantified. For the recovery in economic growth the need for concrete and near-term results is now extreme.
Recovery is in fact happening, but in unexpected ways. China's mercantilist export-and-conquer strategy is in higher gear than ever. Its domestic economy is growing like that of India, at almost pre-crisis rates, at least in certain sectors like car sales, energy sector spending, and commodity buying, but with heavy state and central bank support. In the OECD countries, however, apart from anecdotal and episodic recovery in some car industry activity on the back of 'cash for clunker' subsidies from big government, the economic recovery is at best sluggish and unconvincing. Showing almost extreme disconnect, the 'green shoots' of growth have nonetheless spread across most major stock exchanges, lifting oil, gold, and commodity prices along with most stocks and shares, sometimes to new highs.
Powering this uncertain recovery is massive government borrowing. Several basic conditions are needed for maintaining credibility in this unprecedented public borrowing to finance Keynesian-style deficit spending. These conditions include extreme low interest rates, in turn requiring or at least implying a constant need for low gold prices, low oil prices, little or no inflation, consistent economic growth, and monetary stability.
None of these exist, except perhaps apparent or official consumer price inflation rates, where deflation can be argued, for a while, as being the biggest real threat facing economic recovery. The recovery, in nearly all OECD countries, shows almost bizarre lethargy and unpredictability, that is "low visibility", making for an even more striking and disquieting outlook in the short-term.
The mix of factors in play, now including gold's flirt with the $ 1000 per ounce "ceiling", steady rising oil prices, and world alarm at the US dollar's weakness should sound warning bells in the world's chancelleries, as the expression goes. To date however, and officially, there is little trace of this except mutterings, from some central bankers, that national hyper debt will have to be reduced, but of course only in the longer-term
Gold and Oil Price Disconnect
In the present context, with gold now attracting extreme speculative interest, it is normal that conspiracy theories abound. For gold, the metallic and mining part of the story is usually ignored by media, but physical demand has been outpacing mine and scrap supply by around 1,000 tons a year for about a decade. Central bank selling, from supposedly very large central bank fiduciary stocks, is imagined as able when or if needed to dampen, or even break speculative surges in free market gold prices.
In May 1999, Britain’s Gordon Brown, Chancellor of the Exchequer, announced the sale of more than 400 tons of UK gold stocks in the rather special format of continuous auctions at low prices - an announcement that stopped rallying gold prices in their tracks. Gold prices stayed low for at least 4 years. Unfortunately, this was likely or possibly the last time the central bank selling trick could work, and for two main reasons. Firstly, the British action in 1999 was ultra clearly an organized attempt to hold down gold prices, to shore up the US dollar, GB pound and 'allied' moneys. Secondly, claimed central bank gold reserves as reported to the World Gold Council, and analysts reports and studies, never coincide. Recent studies of probable physical reserve changes, central bank buying, inter-bank transfers of gold, official sales, and clandestine sales make it possible that central banks have much less than the 30,000 tons of gold they claim. Their reserves may only be a half or so of that, only equal to about 6 years of world mine output.
Worse, the 'gold conspiracy' includes at least 15 years during which bullion banks like JP Morgan Chase and powerful private banks led by Goldman Sachs, and of course others such as Lehman Bros until its demise, were able to borrow physical gold from central banks. For this borrowing, they paid extreme low interest rates on artificially low-priced gold, which they resold to ever-hungry major banks, such as Deutsche, UBS, Citigroup, Barclays and others, who then onward sold to other financial intermediaries, as well as private buyers. Due to the artificially low base price, and low interest rates, final gold prices were held low.
We can argue that gold, exactly like crude oil but by different mechanisms, was held at an artificially low price for about 15 - 20 years, only ending, for both, in the past 5 or 6 years. Both served to cap inflation, and strengthen the US dollar and all other fiat moneys. In the current context, however, with today's speculative drive for any performing asset - in the absence of a growing real economy - the potential for extreme disconnect, or in fact reconnection of gold and oil with real world inflation over the past 15 - 20 years, is very high. Both gold and oil are the focus of intense and unremitting speculative interest, able to drive both to high, or record price levels very fast. The return to early 1980s conditions, the time of Volcker's resort to extreme interest rates to fight inflation, high gold prices and high oil prices, could in theory come at any time.
Fast Forward
None of this takes place in a vacuum. The world financial and economic system of today may only be able to operate with extreme low interest rates. During the height of early 1980s Volcker inflation fighting, US Federal Reserve funds rates attained 19.2% per annum in midyear 1981, long after gold prices briefly attained $ 850 an ounce in early 1980, in dollars of the day. Today, many large central banks of the OECD countries set base rates below 1.5% pa. Any prospect for 'Volcker style' stabilization of global currency speculation is impossible, except by unremitting crisis. Since about 2004, for about 5 years, the essentially new twin threats of climate change and peak oil have also emerged as menaces to any recovery of 'belle epoque' economic growth. Both signal high oil prices, high gold prices, and massive but well-hidden inflation. Investment and spending needs to handle the threats of climate change and peak oil are immense. Estimates of needed amounts only grow, while the time horizon only shrinks for action to head off the long-term recession, or worse, that doing nothing will cause.
We therefore have a context in which long-delayed refusal to take these two threats seriously, and mobilize investment for large-scale structural change of the world economy now generates huge near-term spending needs, added to massive Keynesian-recovery borrowing by governments in nearly all G20 countries. Without stable and strong economic growth, meeting this challenge will simply be impossible. If we now add rising short-term speculation against the US dollar and for higher gold prices, with a quick knock-on to oil prices, the rational outlook for sustained and non inflationary global economic growth is almost vanishingly small.
Only using interest rate data, rational argument can be made that the US dollar has bottomed, and should or can appreciate against other currencies because US Federal Funds rates are no longer being cut, while other central banks and monetary authorities have continued to cut the price of borrowing. This ignores the fact these non-dollar fiat moneys can all lose value against gold and oil, food commodities, other hard assets and for a while some paper assets, exactly like the dollar, but faster than the dollar. The fiat money devaluation circus is shifted away from the recent and normal US dollar focus, to other paper currency targets. It can easily return.
Sustainability
In carefully designed press statements and asides, G20 leaders at the coming Pittsburgh meeting will try to square the circle and calm public concern with repeated references to 'reforming and modernizing capitalism', fighting climate change, developing renewable energy and the sustainable green economy, saving jobs, reducing national debts, stabilizing the US dollar, and so on. Their rational capabilities for serious and coordinated action without triggering major market change are however very low.
The key buzzword of 'sustainability' most surely does not fit the will o' the wisp green shoots appearing, episodically, in OECD economies since early Summer 2009. Underlying trends are well shown by a glance at data on world house building and construction, airplane, shipbuilding, ocean freight, iron and steel, car making and other industries. Concerning cars and as noted above, consumers and users can ask the simple question of are they buying a product that will soon be redundant and outdated, due to the climate change-linked, and supposed rapid arrival of mass produced electric cars? If or when electric cars arrive en masse, how are they going to be recharged, assuming that lithium, neodymium and other rare metal supplies are sufficient for building their batteries and motors ? Similar credibility challenges apply right across the spectrum of global economic issues at this time
This makes the potential for system-wide change, either by design or by the force of events, all the stronger and more likely. Quickly summarizing the challenges faced by G20 leaders is simple. They face accumulated no-win economic challenges starting with initial damage due to artificially low gold and oil prices for over a decade, intensified by financial engineering or the creation of untold amounts of derivatives through the last 15 years, followed by Keynesian anti-recession borrowing excesses since 2008, and now extended by climate change mitigation and carbon taxation, green energy feed-in tariffs and subsidies, and obligatorily large short-term investment needs.
There is only one bottom line: uncertainty. Incertitude is most surely the mother of caution, or at least hesitancy, which in markets results in volatility. Volatility in financial markets is traditionally much greater than volatility in its underlying driver, the real economy. Today we however have extreme high, or rising unpredictability in both. This again makes for potential system change, resulting in an entirely new economic cycle arising from the cinders, or shambles of the previous.
