A note of caution about the Gold Standard, and the Euro

Until I looked it up (isn't the internet wonderful?) I had thought that the "Geddes Axe" (which slashed UK public expenditure) was a response to the Depression. Far from it: some would say it was a major cause. It turns out that after the First World War, our politicians wanted Britain to be great again, and thought that meant getting the pound back up to its former exchange rate against the dollar - just as I dream about getting into my old teen jeans.

They managed to do it for a while, but the result was a deflation that failed to take into account Britain's postwar economic weakness, and the 1925 restoration of the gold standard at this fatally high level prolonged the suffering. Then the zip bust.

More recently, some felt that lacing the pound into the Euro would stiffen our backs. Or perhaps this idea owed more to fuzzy notions of European brotherhood, modernity etc - we in Britain have had ten years of being led by a fuzzy thinker.

But not all agreed that the time was right - see the 2002 Cairncross lecture by Ed Balls. This lecture, by the new Prime Minister's former economic adviser (see Wikipedia bio), sets the historical context for the "five tests" that he formulated with Gordon Brown in a New York taxi in 1997. The tests were designed to determine the timing of the UK's entry into the Euro - for details, see this Scotsman article of 2003, which also reviews progress. Perhaps the timing will never be right.

Some hope that's the case -because it's not just about economics. Can Europe ever be a country? What will happen to our mode of government, civil liberties and economic prosperity in this herd-rush towards an "ever-closer union" commanded by a remote, opaque elite?

Is currency stability generally desirable? Sure; but another return to fixed exchange rates would certainly need extremely careful management, especially in fundamentally unstable conditions. I don't think Western trade deficits are purely due to monetary inflation; China's rapid rise from poverty seems just as challenging to our budgets as the Great War that drove us off the gold standard.

It's an ill wind...

A funny piece by Tim Hanson in The Motley Fool for June 26. He makes the point that travelling to a place may not change the facts, but can change your perspective, and he is bullish on some sectors of China stocks.

As you might expect, given that the outgoing tide of wealth from the West is rising in the East and floating Chinese boats. They will bob up and down, and some may tip over, but that seems to be the trend.

Richard Duncan's worry is that the ever-inflating dollar is causing the markets to operate inefficiently, so that China's rise may be preceded by a crisis that creates a long and deep global slump. I really must post a summary of his book soon.

More credible warnings

The Bank for International Settlements is joining its voice to the chorus, warning of excesses and a Thirties-style crash, as reported in the Wall Street Journal for 25 June.

Marc Faber: consumer spending to decrease

Seeking Alpha's Sunday review of fund manager stock suggestions reveals that Marc Faber expects consumer discretionary spending to decrease:

"He calls for a 10% correction by year-end, with emerging markets down 20%."

That may reduce the monthly trade deficit for a while, but won't turn it into a surplus. China's ultra-low wage costs, combined with what seems to be very loose enforcement of intellectual property rights, are still set to hollow out Western industrial production of all kinds, as James Kynge's book makes abundantly and frighteningly clear.

It's all very well finding ways for individual investors to benefit, but if you haven't got spare money to invest, you can't back the winner in this unequal contest. Without some degree of prosperity, what real peace will our countries have? I'd like to see a credible national economic plan from our politicians.

Bulls AND bears buy bargains

If you read the IU article linked to the end of the previous post, you'll see one of the fabulously successful contrarian investors is John Templeton. You'll also see that the foundation of his fortune was investing in low-priced shares in 1939. The macro view DOES have a bearing on investment decisions.

Earlier, I quoted the new Chinese owner of the ThyssenKrupp steelworks, who expects the steel market to collapse again sometime and this is one reason why he bought the works at bargain cost - to survive when others go under because of debt.

Speaking of debt, Bill Bonner opined this week:

A credit expansion is always followed by a credit contraction. And this credit expansion has led to the world’s first, and biggest, planetary bubble. When it corrects, it will be the world’s first, and biggest, planetary bust. So keep your eyes on our Crash Alert flag, dear reader. We may be early. But we won’t be wrong.

The Sunday Telegraph gets bearish

Looking at the recent fortunes of US Treasury bonds, "Sunday Business" Editor Dan Roberts thinks the turning point has come:

I'm sticking my neck out and saying that the time has come. The writing is on the wall...What follows next may turn out to be mild turbulence or the start of a steeper nosedive. Either way, it seems a prudent time to adopt the brace position...

How will China dump the dollar?

Peter Schiff says in Friday's Market Oracle that although Alan Greenspan thinks the Chinese must continue to hold US bonds since there is no-one else to sell them to...

...the Chinese do not have to sell, they only need to stop buying and let their existing bonds mature. Then the U.S. government, not the Chinese, will be the ones forced to find new buyers for its debt.

Most of the debt that the Chinese own is short-term. Therefore all the Chinese need to do is simply not re-purchase new Treasuries when the U.S. pays them for their existing notes. Perhaps Greenspan should rent a copy of the 1981 Kris Kristofferson movie “Rollover,” where the fear that Arab countries would not rollover maturing treasuries sent gold prices soaring.

Of course, even if the Chinese decide to cash out, they will be repaid in dollars, for which they will actually have to find buyers.

[...] To expect 1.3 billion hard-working, underpaid Chinese to indefinitely subsidize 300 million wealthy, over-consuming Americans is absurd. [...] When the Chinese finally wake up the American dream will disappear.

Finding someone to accept the dollars sounds a bit easier, especially if you are prepared to be a bit generous in the exchange. If you were the Chinese, what would you do?

Following this line of argument, if there is less demand for US Treasuries, their price drops and therefore their yield (the ratio of interest to purchase price) increases, which means higher interest rates. Which will make many debtors very uncomfortable or insolvent, and which will also force consumers to cut back on discretionary spending.

Lower demand means more unemployment, I guess, and a falling dollar means imports will cost more; also, exports will be cheaper to foreigners, who can therefore afford to pay more, so rasing the cost of those items in dollars. So, slumpflation for Americans?

But if countries across the world have been inflating their money supply to keep pace with the USA, maybe they will deflate in concert, too. So, maybe simply a deflationary slump, a worldwide bust?

I look forward to reading some expert who can explain the least painful way out of this. Breaking up factories to reduce oversupply?

No wonder no-one wants to be the first to burst the balloon.

Post #100: Hang onto your kettle!

There's a heartening anecdote from the Depression, and an old (2002) article from ThisIsMoney repeats it. 2002, you may remember, was gloomy for investors, and the article looks back to 70 years earlier. Following the Wall Street Crash of 1929, the market took three years to hit bottom, and in 1932 investors were losing hope:

...In New York's patrician Union League Club, members amused themselves by wallpapering an entire room with now 'worthless' stock certificates.

...Bear markets usually end when people have given up all interest in the market. By the later 1930s, members of new York's Union League club were holding kettles to the wall to steam off their stock certificates. They had become valuable again.

Some would say that a bear market has already recommenced, but it's disguised by monetary inflation. The dollar and pound figures distract us from the loss of real value, and the world economy continues to be mismanaged while the temporary fixes hold. Financial history suggests we should prepare for crisis, but also for eventual recovery.

UPDATE:

ThisIsMoney seems to have got the first date wrong (it was March 1934), also the city (Chicago, not NY) and missed out a very vivid follow-up! See the contemporary Time article here.