We’ve caught up on some of David Rosenberg’s recent commentaries for Gluskin Sheff (registration required for trial access), and were surprised to learn of his somewhat dovish disposition towards gold — especially after reading that Jeremy Grantham’s actually buying the stuff. What’s the world coming to?!
Rosenberg has made a name for himself in recent years by foreseeing deflation and rallying long government bonds — calls that he still stands by, perhaps more than ever (we made a similar call earlier in the year based on U.S. political rhetoric). However, under modern monetary systems, deflation, rising government bonds, and a strong currency are irreconcilable with a rising gold price, at least over anything longer than the short run.
Deflation implies a shortage of money. If that shortage persists, eventually all or most prices will come down, even if relative prices (e.g., the number of eggs exchanged for a quart of milk or a certain amount of gold or silver) do not move. And because most debt contracts are priced in nominal rather than real terms, this causes carnage in credit markets, e.g., waves of default, bankruptcies, and restructuring.
Under metallic monetary systems, it worked the other way — when gold or the precious metals underlying the system were in short supply, this meant that money was in short supply too — thus, both gold and money would increase in purchasing power, followed by defaults, bankruptcies, and restructuring.
Under fiat monetary systems, precious metals are nothing more than a barometer of inflation (rising) and deflation (falling), and like any other prices, they are subject at times to human error and herding. And today, with everything on the planet flashing deflation ahead, there is simply no fundamental reason for gold prices to increase.
So why has gold been rising? It’s most likely due to the fear that policymakers will use inflation to involuntarily “restructure” public sector debt. Along these lines, in today’s piece, David quoted an email exchange that in turn quoted an op-ed by economist John Cochrane, arguing that governments will be tempted to inflate their way out of the current crisis (emphasis added):
Did you read Cochrane’s op-ed? While we face a deflationary near-term future, the temptation will be to go through a door which, somewhat inevitably, will lead to inflation.
Here’s the thing though – if there’s outright deflation, then monetizing debt, be it sovereign or private, cannot be inflationary until deflationary pressures have been completely extinguished. This idea simply mirrors the concept of ”disinflation” that has held currency with economists from the 1980s into the 2000s — similar to how today’s environment is an inverse reflection of the episodes that have people like Cochrane wringing their hands about inflation, and gold bugs screaming that the sky’s the limit.
Is it disdeflation? Whatever we choose to call it, it is not a “door” or a magical threshold that is instantly crossed as soon as central banks monetize interest bearing debt, or treasuries credit accounts with new units of money. It’s more like a long passage, with plenty of room between here (deflation) and there (inflation). Most importantly, there are places along that passage that offer a sounder economic and financial footing than what we’re currently on.
UPDATE 5/19/2010 - We thought we might have coined something new here, but it looks like the term “disdeflation” has been used before, and as far back as 2001 by Julian Wiseman and 2005 by Don Luskin. Note, though, that it only produces ten hits as of today, while “disinflation” produces 237,000, “inflation” produces 41.6 million, and “hyperinflation” produces 1.2 million. Suddenly, the learning curve ahead of us looks rather steep…although to be fair, “deflation” produces 3.4 million hits.
UPDATE 5/20/2010 – An excellent letter to the FT from Dr. John Whittaker of Lancaster University in the U.K. stating the obvious: “Even without sterilisation, there is no reason why this “monetisation” of debt should cause inflation. If banks were to lend out the extra cash they receive from selling the bonds to the ECB, this might lead to demand pressure on prices. But the banks are still repairing their balance sheets and this cash injection is unlikely to change their lending attitudes at present.”
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