Harry Bingham is not only one of the leading experts in the world
on gold but he is also a terrific friend. On November 18th Harry
gave a speech to the London Bullion Market Association and, in a
slight change for this particular link, I thought it would be useful
to reprint Harry”s speech (with his permission, of course).
——-
There was a time around the last turn of the century when gold
was the most contentious political subject in America. Three
presidential campaigns were waged on this issue and three times
the alleged crucifier of mankind triumphed. The press was
gleeful. “You fight about it and we”ll write about it,” they said.
Frank Baum even wrote a delightful classic about the gold
controversy which was finally produced as a timeless movie, “The
Wonderful Wizard of Oz” – Oz of course standing for ounces of
gold and the wizard for our beloved President William McKinley,
champion of the gold standard. Dorothy, although enchanting,
was on the wrong side of the issue.
A recent edition of the Wall Street Journal noted that Republican
presidential candidates extol Ronald Reagan”s administration as
the Gold Standard of politics. Eight-five years after the demise of
the International Monetary Gold Standard the expression gold
standard still retains the mark of excellence. Could that be
because during the intervening eighty-five years the best paper
monies, untethered to gold, have lost more than 90% of their
purchasing power value while others have been totally obliterated
one or more times?
This year, gold, under severe attack and at its lowest ebb in more
than twenty years, still retained more than 70% of its 1913
purchasing power. Today, having scored a victory, gold is very
close to its pre-World War I parity with goods and 15 times its
pre-War parity with the dollar.
In McKinley”s time the enemy of gold was silver, a subsidiary
form of money. Paper was a convenient receipt for money and
was called a note. Credit itself was useful, but was disdained by
most, and when speculatively used led to booms and panics even
under the stringent limitations the gold standard imposed.
Last month in a letter to the editor of “The Alchemist” I wrote
that the European central banks” September 27th statement to
restrict additional gold supplies was a seminal event. This may
have been a bit optimistic because in the words of Geoffrey
Chaucer, “When you dine with the devil, use a long spoon.”
Three quarters of a century ago central banks began an attempt to
eliminate gold as a discipline to the creation of paper money and
credit. They finally succeeded temporarily in 1971, when the
United States officially refused to redeem dollar denominated
notes for gold. Subsequently, a fierce attempt has been made to
remove from public consciousness gold”s role as a measurement
of the value of paper money.
This attempt failed abjectly during the 1970”s, but supported by a
great bull market in shares and gilts, gained momentum during the
1980”s and 1990”s. This bull market is extraordinarily important
because it sanctified the great credit inflation of these decades.
On its face credit growth looks to have been slower during the
1990”s than during the 1970”s. In reality it has been faster when
the leverage affect of derivatives is included – these having grown
from virtually nothing in the 1970”s to $85 trillion notional value –
today have contributed mightily to the unprecedented vitality and
durability of the bull run in shares and have contributed just as
mightily to gold”s strategic retreat.
At the moment I am not attempting to judge the valuations in the
securities markets. I am only suggesting that the shift in the use
of credit from the pursuit of commodities to the pursuit of
securities, for whatever legitimate or spurious reasons, was a
great ally of central banks in their effort to “demonetize” gold.
There is good documentation that over long periods of time gold
maintains its value. During periods of market euphoria and
despair, however, gold becomes the reciprocal of the values
placed on shares, gilts and currencies. Even in a fixed exchange
regimen gold lost half its purchasing power value during and after
World War I and then regained all of it and then some in the
1930”s.
There is a text book definition of money, but temporarily money
may be whatever people think it is. People may even temporarily
mistake credit for money. There is a saying on Wall Street,
“When the ducks are quacking feed them.” After World War II
there was some question about the value of currencies in terms of
gold. World Central Banks then held 70% of all the worlds gold.
They were able to suppress the ducks until multitudes began
quacking in the 1970”s. Then with all their might they could not
stop a gold bull market. These weren”t ducks after all, and
people finally distinguished money from credit.
The small sales of gold by central banks during the 1980”s and
1990”s were de-minimus in terms of the gold market, as were the
increases in gold production during the 1980”s. Even then new
mine supplies never added more than 2% a year to above ground
stocks. The leasing of gold for new mine development and for
modest price protection for the mines was also insufficient to
account for the remarkable decline in gold”s perceived value.
The analysis of the price of gold is more akin to bonds than to
commodities. That is because virtually all of the gold mined and
most of the bonds issued are still outstanding. Unlike
commodities, bonds and gold are issued and produced for
accumulation rather than for consumption. There is a continuous
bid and asked market for both bonds and gold. Their prices
reflect the value that all the holders and potential holders place on
all the gold and bonds outstanding. Isn”t it remarkable that the
great government bond bull market in the United States during
the 1980”s occurred despite the greatest issuance of new
government bonds in history and that bond prices have fallen this
year despite an absolute decline in the amount of US government
bonds outstanding. Perception of value is the reason.
A demoralized market can be further demoralized until it reaches
bottom. The final culprits in gold”s case were the carry trade
operators. These speculators had a vested interest in depressing
the gold price. All that stood between themselves and a limitless
sequence of profits was a sharp and sustained rise in gold”s price.
Speculators flooded the market with rumors of central bank sales
and the disdain with which their bureaucrats held gold. Central
bankers, I think, finally sensed that they were being regarded as
dupes by these speculators who thrived on the losses central
banks were suffering. That is why the first point in the September
27th communique was: “Gold will remain an important element of
global monetary reserves.” Deep down central bankers may
detest this concession to gold, but for now and for some time to
come they have no choice except to honor it. No choice now
because a quick policy reversal so soon after sustaining dreadful
losses of their own making on a public treasure so basic to central
bank management as gold would risk the loss of public confidence
in central banking itself.
Central banks likely have little choice in the longer term because
the degree of confidence in monetary institutions changes with
economic conditions. During the 1920”s the Federal Reserve was
revered as the institution that had saved the banks and conquered
the business cycle. By 1932 the system was in disrepute and its
structure was radically altered. Then less than a generation ago
central banks were universally defined as “the engines of
inflation.” A seventeen-year bull market changed that perception.
No bull market in this century, or the last, has survived for a full
generation. Engines of economic activity and markets change.
What does not change, but what a bull market may conceal, is the
distinction between money, which is an owned asset, and credit,
which is an owed liability. A bear market in shares and gilts
clarifies that distinction.
This is the evidence of a bubble in the markets. The multiple of
debt to GDP including inflation in the United States was stable
throughout the 1960”s and 1970”s but has since skyrocketed as
excess credit has been absorbed by a seemingly endless bull
market in shares rather than by what was once seen as endless
inflation.
Alan Greenspan is concerned about the decline in the risk
premium on common stocks. But the mother of all declines has
been the decline in the risk premium on paper money. Share
certificates at least represent real assets, albeit at excessive
valuations. Shares also represent intrinsic value, which may rise
or fall. Paper money today represents no intrinsic value and
reflects only confidence in the virtue, wisdom and continuity of
central banks. Once this confidence wanes the value of paper
money will wane with it. This may take more time because as
Charles Mackay, author of “Extraordinary Popular Delusions and
the Madness of Crowds,” wrote: “Men think in herds. They go
mad in herds but only recover their senses slowly and one by one.”
On the other hand, in an October 14th speech about risk
management, Chairman Greenspan said: “History tells us that
sharp reversals in confidence occur abruptly with little advance
notice.” He went on to suggest that banks increase their reserves.
He said: “These reserves will appear almost all the time to be a
sub-optimal use of capital. So do fire insurance policies.” What
he didn”t say is that cash protects cash but gold may protect the
accumulated wealth of a generation.
Nevertheless, at the recent Jackson Hole monetary symposium
there seemed little inclination to view the rapid rise in share prices
as a harbinger of inflation or excessive speculation. Uninvited to
the symposium was an official of the Bank of England, Charles
Goodhart, who defines inflation as a decline in the value of
money. He concludes that a rise in the price of a house or shares,
which are claims on future services, should be counted as inflation
just as much as a rise in the price of carrots or cars.
The greatest threat to financial market stability and confidence in
paper as I see it are:
1) Inflation. This is obvious and requires no elaboration.
2) Trouble emanating from blistering credit growth which
continues to far outpace economic growth. Ironically, on the
very day that the Federal Reserve warned American banks about
low credit standards, the Federal National Mortgage Association
announced an easing of credit requirements on mortgage loans.
There is nothing more damaging to confidence than vanishing
credit availability.
3) The world may be locked into a continuing coordinated
monetary expansion. The banking and credit systems of Mexico,
Brazil, Argentina, Ecuador, South Korea, Thailand, Indonesia and
even Japan are in varying states of disrepair, and some continue
to deteriorate. Emerging market income statements have
improved thanks to rising exports, official financial aid and the
roll-over of billions of dollars of foreign bank loans, but their
balance sheets remain in perilous condition. Imagine what would
happen to the finances of these countries should the Federal
Reserve actually tighten monetary policy and throw the United
States into recession. Imagine what would happen to confidence
in central banks in general if their policies were to be seen to have
caused another round of emerging market economic turmoil.
The Federal Reserve would like to tighten credit to cool the
economy but dares not because of the potentially disastrous
affects on consumer finances and fragile emerging markets.
You know, Irving Fisher, the renowned economist of the 1920”s
is best remembered for his October 1929 remark that stocks had
reached a permanently higher plateau. Less well remembered is
his comment three months later: “Stock prices were rising three
times more rapidly than earnings. There was no statistical
precedent by which to judge to what degree prices were entitled
to out run earnings, but when stock quotations get to stepping
thrice as high as the intrinsic values behind them, it should be time
for careful people to stop, look and listen.” Professor Fisher had
quickly seen the error of his earlier opinion. But even he could
hardly sense that in less than three years the Dow Jones would
collapse 89% to a level not seen since the creation of the Dow
Jones averages in the 19th century. What Professor Fisher may
have missed at the market”s peak was that the excessive credit
creation that funded the stock market boom inevitably had to lead
to general price inflation or to a bubble bursting crash as it had
throughout history – and also throughout history been the perfect
prescription for a gold bull market.
The world is engaged in a coordinated monetary expansion in the
midst of strong deflationary forces. But as was proved in the
1930”s, deflationary forces are the wombs of devaluations which
are fathers of the next inflation. The American consumer price
index has never again been as low as on the day President
Roosevelt, at the bottom of the depression, called in American
gold coins and then devalued the dollar against gold. The truth is
that to this day not every nation can devalue at once, except
against gold.
In 1972, when gold was $59 an ounce an old friend, Douglas
Johnston, suggested that his clients might make a killing in gold
shares. He wrote: “Nothing has been less popular than the
subject of gold. Congress is against it. The Federal Reserve is
rabidly against it. The Treasury reads gold”s funeral oration
several times a year. Only a handful of mutual funds owns any
gold shares. Virtually none of the banks, insurance companies or
pension funds own any. The press and college professors
lambaste gold without respite. It is precisely because they are so
unanimous against gold that opportunity exists for an
unprecedented killing today.” Less than a year and a half later
gold was almost $200 an ounce and a killing had indeed been
made. A similar opportunity may exist today, because as a Wall
Street sage once said, “Bull markets are born in pessimism, grow
in skepticism, mature in optimism and die in euphoria.” Or as a
line from the Communist Internationale goes, “The volcano is
thundering in its crater. The final eruption is at hand” – but not
the one the communists had in mind.
I would like to end with quotes from a few Englishmen past and
present.
John Stuart Mill 150 years ago said: “Money is like a machine for
doing quickly and commodiously what would be done less
quickly and commodiously without it, and like other types of
machinery it exerts an independent influence only when it gets out
of order.” As Christopher Wren said, “Look around.” Then,
Lord John Maynard Keynes – no friend of gold – said soon after
Britain”s departure from gold: “The metal gold might not possess
all the theoretical advantages of an artificially regulated standard,
but it could not be tampered with and had proved reliable in
practice.” I wonder how reliable Lord Keynes would think the
artificial non-gold system is, now that the pound has lost 95% of
its pre-1931 value. Perhaps that happened because since 1931 the
pound has been tethered, not to gold but to government bonds,
about which Benjamin Graham once wrote, “At bottom they are
no asset at all.”
More recently Robert Sleeper of the Bank for International
Settlements at this year”s Financial Times Gold Conference said in
reference to gold: “This market is still the most sensitive to all the
fears and uncertainties in the world and when a rebound occurs it
will take few prisoners.” He concluded: “Central banks
themselves are most sensitive to the vulnerabilities of the world
economy to the many exogenous forces that could potentially re-
ignite inflation fears. It is for this reason that central banks will
always hold gold. It is still their job to protect the financial
system from crises of confidence in fiat currencies.” In his
prepared text Mr. Sleeper capitalized each letter of the word
FIAT; perhaps because throughout history all fiat currencies have
eventually approached their intrinsic value.
Best of all was Sir Peter Tapsell”s message in The House of
Commons as he attacked the British government”s decree to
exchange gold for paper: “The Chancellor may think he has
discovered a new alchemist”s stone, but his dollars, yen and Euros
will not always glitter in a storm, and they will never be mistaken
for gold.”
And now a final reading of Edward Lear”s 19th century limerick:
The owl and the pussycat went to sea
In a beautiful pea green boat
They took some honey
And plenty of money
Wrapped up in a five pound note.
Editor: Harry Binghan is a portfolio manager with Van Eck
Associates. He is also the manager of the PIMCO Precious
Metals Fund (PIMCO was where I used to hang my hat). If you
are interested in more information on the fund, you can contact
my good friends at PIMCO at 1-800-628-1237. If you simply
want a copy of the prospectus, you can contact them at 1-800-
426-0107..Brian Trumbore
