Conundrum

Some gold specialist and investor and adviser suggested that gold and silver are now the things to hold onto for wealth and for the keeping of value, nay, for increasing the value of wealth. 

The argument is that the interest rate is going to go sky high to as much as 20% per annum and more. This means that debtors will default and banks will go bankrupt - which we agree.

The government will also default but it will respond by printing more money which will make money worthless - which is debatable.

In the money-using world that we are living in today, there will always be money which is currency which can be paper or electronics. It doesn't matter the form, but the accounting. Whatever item that is going to play the role of money in the world economy will have to be managed properly for the money to stimulate the economy and keep it going for as long as the economy can. For a fact, gold and silver will not replace the currency as money, be it the US dollar or something else. Somebody go to print enough money for the economy grow smoothly.

Just to close the argument with the gold investor specialist, when the interest rate hits 20% per annum and more, money will flow from gold and silver to the currency because it is giving such a good return. Money has been going to gold and silver because of the near-zero interest rate for the currency, thanks to quantitative easing. The point we are trying to make here is that it is not true that gold and silver will continue to go up in price when the interest rate goes up significantly. Gold and silver prices are likely to crash because of the speculative nature of the buying of precious metals.

An underlying argument of gold is that central banks are now trying to replenish their holdings of gold in their reserves. This is true to BRIC which is trying to create a new international currency to replace the US dollar. The only argument they have is that the proposed new international currency will be backed by gold - going back to the gold standard. The fact that the gold standard was abandoned by the US in 1973 was because it limited the growth of money for sustainable trade especially after the hike in the price of oil at the time. If all the money were to be used to pay for oil, then there would be insufficient supply of money for the rest of the economy to grow. Abandoning the gold standard was correct. So if BRIC wants to go back to the old regime of managing the reserve currency, it is likely to face similar problems regarding the rigidity of the management of the money supply. Let BRIC buy gold and we'll see what they can do with their proposed new international reserve currency.

Apart from BRIC, ordinary holders of gold will sell when there are signs of gold price coming down especially when there is an alternative way to obtain a higher return on their money.

For sure, the interest rate is going to go up. Now that the US has hit again its limit on the federal deficit, this means that there is already a slowing down in the expansion of the money supply when there are no new base money to stimulate loan expansion. The economic dynamic is a very fragile thing. The moment the upward momentum is killed, the downturn happens immediately. This is because the markets are now so transparent and live and market reactions are now extremely rapid. After four decade of quantitative easing and easy money, a long period of downward adjustment is bound to happen and so many events are trying the reversal of the global economic boom. First, covid. Second, Russia invasion of Ukraine. Third, China overproduction and global dumping and the US tariffs. Fourth, the lack of funding for the US federal government. All these have stopped the issue of new loans globally and hence the growth of the money supply.

The only people who have plenty of money or cash are multinationals and private equities. These are not normal businesses as we know them - honest entrepreneurs working with neighbours to produce goods and services for the purpose of taking care of the workers (and owners) and their families by satisfying the needs of customers. The concerns of national governments used to be to stimulate investment and create jobs so that all able-bodied citizens can get a decent job in their neighbourhoods. Now, this is no more. National governments attract multinationals to invest by offering tax holidays and tax concessions and even cash incentives to create jobs for lowly paid foreign workers so that at the end of the day, the rate of growth of the GDP looks good - good enough to argue for another term in the political office. Foreign investors especially private equities are out to make their money back plus an extremely high rate of return within a couple of years or so. They raise selling price and suppress wages and they can do that in an environment of high liquidity. There is no doubt that quantitative easing and easy money has made the lives of ordinary workers miserable with suppressed wages and inflated asset prices especially for real estate.

Of course, we are all sitting on our hands waiting for the downward adjustment to unravel itself, as it is now doing. Quantitative easing and easy money has inflated the ego of China who is now going for world domination. Sure, in the long long term, the China economy with its modern infrastructure will surpass that of the US economy with is aging infrastructure. It is a great mistake to dismiss the need to manage the money supply probably and rely entirely on the superiority of the production function. In a deprived economy, there is a need to increase the output because there is a desperate need for it. Once the need is satisfied, it is often likely that output capacity is overshot because of the lumpiness of industrial investment projects. This is where the trade cycle shows its face. And this is where demand management becomes an art which must be left to the trained professionals.

After four decades of printing money, how is the excess money going to be destroyed? Insolvency. This is where merchant banks or investment banks will be at work. For you and me, you keep gold, I keep cash. In the short term, it is good to have money to spend. 

Days of Reckoning

When times are good, people think they're being clever.

When times are bad, they wondered why.

If they had known, they would not have gone that far.

But it's their cleverness that had brought them to where they are.

It is very sad to realise how people have brought trouble to themselves

We only wish they hadn't. But who are we to tell them so.

The writings on the wall.

1. They had decided on a global liberal economy where labour and capital can move freely.

2. Europe with its fear of stagnation opened up to the free movement of labour.

All that they got is the free movement of Islamic extremists.

3. Capital is free to flow. The US Fed print money and the money went to China to make use of the cheap labour, They lost the capital and the intellectual property.

4. China, feeling rich and capable, use their surplus reserves to buy minerals in Africa.

5. It is inevitable that China will rise and the US will fall. China has newer infrastructure and the US infrastructure is decades old.

6. While the global transition is going to be a gradual process from the US to China, the usual impatience of Marxists to allow historical transition to take its course is ignored and a forced transition is tried. China says it should be the dominant economies and the US economy is in descend.

7. The US while in descent is not without economic and political power and China in ascent is with no economic nor political power. Impatience kills.

8. The US in decline will not decline without a fight. The US still has enough power to kill China.

9. The US dollar is still the reserve currency. Whoever think they can device a good alternative is utterly lack of education on the history of money.

10 While China may strive to live without the US and may possibly succeed, this does not mean that the US is without dominance in the world economy.

11. With the tariff war, the world economy is doomed to recession and high unemployment.

12. China currently suffers from delusion of grandeur, while the US is struggling to stay above water.

13. China for the moment cannot live without the US.

14. The US economy will dominate for the next 5-10 years.

15. The China economy is still in the infant. It has not treated its workers well.

16. It is easy to print money - in the US and China. After printing money, how do you retrieve money from the system?

17. The only way money dies is for banks to go bankrupt.

18. When banks do not lend, the economy goes into recession.

19. Economic growth is borne out of confidence.

20 When there is no confidence in politics and economics, recession looms. 

Tariff War

A tariff is imposed because the deficit economy is caught in a downward spiral because the surplus economy fails to adjust properly.

The theory is that the surplus economy, as a result of the increase in foreign exchange, will have a strengthening currency which leads to a loss of export competitiveness which then gives the deficit economy a chance to compete and recover its external trade position. 

This does not usually happen in the now of China and in the past of Japan where their respective currencies are being held down deliberately either by maintaining low domestic interest rates or by managed foreign exchange policy.

It is a long-held belief that an external trade surplus is indicative of good economic health. 

Of course, it is better to have a trade surplus than a trade deficit. 

But it is not good to always maintain a trade surplus which means than other economy or the rest of the world has to run a trade deficit forever which it clearly cannot. 

(If the trade surplus economy is small, then the problem is not that serious, as in the case of Singapore.) 

By maintaining a sustained trade surplus, it means that the domestic industries are deliberately keeping down the cost of production especially wages and the benefits to workers while profits are ploughed into machinery to keep increasing productivity.

A social and political policy question arises: What is the benefit of a sustainable trade surplus when the working population does the enjoy much of the fruit of the surplus? Are people meant to work the machinery and hence work like machines as well?

Of course, the trade surplus has also the effect of flooding the domestic economy with liquidity. The local banks choose to direct their new loans at real estate which seems to the practice all round the world in the last few decades. The problem with real estate is that it is also a good collateral for banks for their loans, so as real estate prices increase, asset inflation escalates new loans to real estate again, thus accelerating asset inflation.

The banks think they have good collateral so when the asset price bubble bursts, as it is happening now, the banks will end up owning the real estate themselves. In asset deflation, the banks will be loaded with bad loans enough to send them into insolvency due to lack of reserve provisions as the directors have pocketed the profits (which had encouraged them to be reckless in their lending).

Now, what should the surplus economy do when faced with tariff imposition by the deficit economy? A non-economist will think that it is war, call it economic war, and retaliate. Even at war, one probably does retaliate but possible try to defend. 

To retaliate means that: since you are hurting my industries, I too will do the same to hurt your industries. 

To defend means that: since you are hurting my industries, I will do my best to ensure that my industries are not hurt too much. How can you do that?

One is to provide subsidies to the hurt industries. This may not be a good move because you will be accused of further distorting fairness of trade.

Two is to negotiate to see which aspects of the trade is deemed to be unfair. It has usually got to be concerned with the (allegedly) suppressed exchange rate, the too low cost of production such as excessively low wages, poor worker welfare and all those things dealing with labour which the deficit economy has been doing to improve human welfare in society. To undertake a negotiated worker welfare programme for the labour force may be a good first step.

Of course, what has happened with the surplus economy is that it has tried to spend its surplus in third world countries to try to secure raw materials for future growth. This diversion of the trade surplus could probably have also weakened the force of adjustment for the benefit the deficit economy. This is like a three-body problem which means that there is no possible stable working equilibrium to be established between the surplus economy and deficit economy (which the conventional theory espouses) because there is a third party economy involved to which the equilibrating energy is diverted. With no equilibrium in sight, it is natural that the deficit economy wants to put a stop to its deficit run and start rebuilding its economy with a new paradigm. The same goes for the surplus economy which will now have to find its new working model without the prevailing deficit economy.

If the now surplus economy now wants to circulate around its own orbit, it will have to find another economy with a big deficit to fund its desired surplus. This is unlikely to happen firstly because of the deficit size to be replaced but because it will then have to accept a new currency for its foreign currency reserves. At the moment, there is no such single currency that could be deemed acceptable.

There has been an apparent drive to sell the US dollar for gold which can be kept as reserves. When you keep gold in your vaults, gold does nothing as it sits there collecting dust. In the end, you may try to issue your currency as a receipt to an actual amount of physical gold. It would be much better than bitcoin which is an artificial digital construct on an arbitrary basis.

The problem with a currency on the gold standard is that if you allow the gold to be redeemed, you may end up with no physical gold and lots of paper money.

There is no way in a money-using economy that you can do away with money as a unit of final settlement. It is the ability of the fractional banking system that allows money to be created through the expansion of loans, and when the new loans are properly vetted and used, that money creation helps to expand the real economy. It is a fact that the expansion of the US money supply helps to raise the China economy as new US loans were spent on investing and building factories in China and in the process built up the foreign reserves of China.

For China now to discard the US dollar as its foreign reserves by divesting into monopsony and gold, is an attempt now to play the economic game with the US. It is therefore logical that the US should stop this bilateral economic understanding and enforce a structural break even just for the sake of trying to reduce the deficit problem. Like everybody when we try to reduce our debt, we consume less output thereby causing a recession.

A tariff war ends up in recession. This is a fact. 

Tariffs

 A country imposes a tariff to increase the cost of imports of similar goods which are being produced at home due to higher local costs such as higher wages, higher rentals, and higher quality such as tighter QC. Tariff gives the local industry a chance to survive or grow.

The country on whose exports tariffs have been imposed may want to retaliate by imposing tariffs on imports from the first tariff-imposing country. It is not likely that it will be on the same products but probably products which are competing locally or even not.

The end result is that prices of goods and services will rise in both countries on all things with tariffs imposed. There are other consequences. Tariffs are usually imposed with times are tough for local industries. This means higher prices with probably slowly growing demand. These tariffs suck up purchasing power from the local economy into government coffers and this comes in handy as governments are suffering huge deficits around the world. The net impact is smaller quantities consumed and hence production cut. 

Economic recession is inevitable, even if tariffs were originally imposed to restructure global economic balance. 

Economic restructuring usually means some industries will die and new ones come up.

The current global economic problem is something that is waiting to happen and we were not so sure how that was going to happen. This round of tariff imposition among trading countries is surprising but anything could have happened to trigger a global adjustment. For sure, this also means that the US is unlikely to print more money and so we should see a sharp drop in global liquidity and a massive contraction around the world, hitting real estates and banks.

What is happening is something we have been expecting - a massive adjustment in the global economy. A slowdown and recession will take place in the next few years, and it will be sad to see the economic adjustment and deterioration descending into military warfare.