Today, I am publishing some articles from The Economist, because I noticed that they are temporarily free online and make a very interesting reading.
The first one below is an old Economics focus that seems to predict a rise of Gold (which is rare in the Economist newspaper). The others tend to exhibit the usual bias against Gold, and lastly I copied a whole special survey about Investment Banking that contains everything you need to know about modern exotic products such ad CDO, CDS, and more.
Of course they don't recognize the whole extent of the risks that exist in this system
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Economics focus
Heading for a fall, by fiat?
Feb 26th 2004
From The Economist print edition
The trouble with paper money
IS THE problem with the dollar only that it is falling? It has certainly been doing that. This month, it fell to $1.29 against the euro. This is its lowest-ever rate against the euro, and represents a decline of 19% since the beginning of 2003. In trade-weighted terms, the dollar has fallen less over the same period (15%), but mainly because Asian central banks have been intervening heavily to stem their currencies' rise against it. Of late, it has been wobbling around unconvincingly: America needs a weaker dollar to correct its current-account deficit. But given the dollar's role as a currency of last resort, some wonder if its decline heralds not just an economic adjustment by the United States, but a crisis of sorts in the value of paper money itself.
Money in its present form is a relatively new invention. For most of human history money meant either gold or silver, either directly, or indirectly by means of the “gold standard” which meant, at least in theory, that all paper money was backed by gold. Enthusiasm for the gold standard evaporated in the 1930s, when it made dreadful conditions worse. But it was adopted in a watered-down version after the second world war, when only the dollar was backed by gold. This arrangement made some sense, since America held three-quarters of the world's gold stock. But it came to an end in 1971, when inflationary pressures in America caused the country's manufacturers to become uncompetitive and forced the country off the gold standard. Since then the world has relied on “fiat money”, so-called because it is created by government fiat and is backed only by the promises of central bankers to protect the value of their currencies. It is the value of those promises that some are now questioning.
Promises, promises
Certainly, those promises have only been worth much in recent years. In the early years of fiat money, inflation took off, especially in America, in part because of the two oil shocks of the 1970s. This debased the value of the dollar, and the price of gold climbed from $35 an ounce to $850.
It was only in 1979, in his famous “Saturday night special”, that Paul Volcker, then chairman of the Federal Reserve, raised interest rates sharply to clamp down on inflation. The gold price subsequently fell sharply and in its place came a bull market in government bonds that has, with a few sharp interruptions, continued to this day. Although central banks around the world still hold about 30,000 tonnes of gold in their reserves, many have been offloading their stocks over the years. They can earn only a nugatory rate of interest on these stocks (by lending them out) compared with what they can earn on government bonds. For most people, gold has been relegated to the status, in the words of Keynes, of a “barbrous relic”; its price has risen only feebly when investors have fretted about inflation.
Those who doubt the continued worth of paper money as a store of value point to two things. The first is that the price of gold has been rising even though official inflation is low. From $253 an ounce in the late 1990s, gold now fetches just over $400 an ounce, and it rose as high as $430 an ounce earlier this year. It is not just the price of gold that has been rising: so, too, have the prices of precious and base metals. There may, of course, be many other reasons for these rises. China's rapidly expanding economy is gobbling up metals and other commodities for its factories. Moreover, the rise in the price of commodities also reflects the weakness in the dollar: these rises look much less impressive when quoted in euros or yen. But the rise in the price of gold in particular has raised questions.
The biggest of these—and the second main reason for concern—is the amount of debt that rich-country governments have been running up. America's official budget deficit has surged in the three years since George Bush became president, to around $520 billion and climbing. But this is just the shortfall this year. The government's total future liabilities are much larger. In fact, according to a forthcoming book by Laurence Kotlikoff, an economist, the present value of the American government's future obligations, taking into account promised pensions and health-care benefits, is a staggering $45 trillion. European governments are only slightly better at managing their budgets—witness the breaching of the single currency's growth and stability pact. Japan's attempts to coax its economy back to life have left it with a gross national debt of some 160% of GDP, the highest of any big country. No country has tried harder to debase its currency.
In theory, such debts would not be tolerated for long by investors, since the easy way out for central banks is to “monetise” them with inflation. Bond prices would fall (and thus yields rise) as investors worried that they would be paid back in a debased currency. But capital markets currently seem oblivious to spiralling debts. At some 4%, yields on ten-year American Treasury bonds are close to their lowest in two generations, although this is partly explained by huge purchases by Asian central banks. Yields elsewhere are also very low, nowhere more so than in Japan, where ten-year government-bond yields are now 1.3%.
The problem may be that bond investors, far from being far-sighted, are in fact myopic, and are perhaps being fooled by the temporary disinflationary effects of excess capacity and debts built up over the bubble years in both Japan and America. Perhaps, too, investors have been lulled into a false sense of security by the performance of central banks in recent years, and the independence that has been granted to many of them by governments. But this very aura of inviolability may be storing up problems, since it means that governments can borrow still more at cheap rates. And if governments then find themselves crushed by debt, you can rest assured that this independence will be taken away. And then, once again, the paper in your pocket will only be as good as a politician's promise.
Showing posts with label paper currency. Show all posts
Showing posts with label paper currency. Show all posts
03 June 2007
All that glisters
Buttonwood
All that glisters
Nov 30th 2004
From Economist.com
Is the rise in the price of gold merely the flipside of the dollar’s fall? Or does it point more broadly to a loss of faith in central bankers’ promises?
ALAS, the nearest that Buttonwood gets to visiting jewellery shops these days is a trip to Claire’s Accessories, a chain of fabulously tacky shops beloved of his daughters. To be fair, Claire’s (“Where getting ready is half the fun”) does not pretend to be anything other than cheap and cheerful. Nothing seems to cost more than £2.99. The jewellers in Bond Street, just round the corner from The Economist’s offices, are about as different from Claire’s Accessories as it is possible to get. The stuff in them costs rather more than £2.99. And their already steep prices have been going up because the prices of precious metals have been rising, gold’s not least. In the past week, gold has topped $450 an ounce, its highest level in 16 years—and up from a low of $253 in the late 1990s. What, if anything, does this tell us about investors’ faith in paper currencies.
The financial world, it sometimes seems, is broadly divided into those who believe in gold as the ultimate currency and those who don’t. In the latter camp are most economists, the most famous of whom, John Maynard Keynes, described gold as a “barbarous relic”. But even as late as the 1960s, Charles de Gaulle, then president of France, claimed that gold was the “unalterable fiduciary value par excellence”.
Gold or silver were money for most of human history, either directly or indirectly. Once paper currency was introduced, it was, in theory at least, backed by either of the two metals. Silver was gradually edged out as a monetary metal in the 19th century, from which time the “gold standard” reigned supreme. This arrangement, in its purest form, collapsed in the 1930s, but it continued in a bastardised form after the second world war, when America, which by then held three-quarters of the world’s gold reserves, again tied the dollar to gold, and the rest of the world’s currencies tied themselves to the dollar. In 1971, the dollar was forced off the gold standard because of mounting inflationary pressures. Since then the world has had so-called fiat currencies, which are backed by nothing more than the promises of central bankers and politicians that they will uphold the value of those currencies. Fans of gold—known as gold bugs—wonder whether those promises are worth the paper they aren’t written on.
They certainly weren’t in the early years. Inflation ate away at the value of anything with a fixed monetary value, and during the 1970s the price of gold rose from $35 to $850. But in 1979, Paul Volcker, then chairman of the Federal Reserve, stomped on inflation and the price of gold fell sharply. In its place came a bull market in the price of government bonds.
The dollar, it must be said, fared less well. It may have become the world’s reserve currency, even without the backing of gold, but it has been anything but a splendid investment, especially in recent years. While its internal value has not fallen as much as it once did, thanks to lower inflation, its external value—ie, in relation to other currencies—has been in remorseless decline, albeit punctuated by some longish rallies. In recent weeks, encouraged by malign neglect from American politicians and central bankers, the fall has shown signs of becoming a rout. As the dollar has fallen, so the dollar price of gold has risen.
It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world. Why, then, is gold prospering at a time when inflation is low? Perhaps it reflects nothing more than the fall in the dollar: gold transactions are denominated in dollars, and in euros the rise in the gold price has been anaemic.
However, there is no law that says a falling dollar must translate into a rising gold price. Apart from a rise in demand for jewellery, the rise in the price of gold may, at the margin, reflect demand for real, hard assets, as opposed to the paper sort. And the reasons are not hard to find, for across the developed world, debts have escalated alarmingly in recent years—and in America not least, hence the vast and growing current-account deficit. While central bankers are generally trusted not to “monetise” these debts by rolling the printing presses, history would suggest that this displays a touching naivety. As James Grant, publisher of an eponymous financial newsletter, and the most erudite of the gold bugs, says: “[Alan] Greenspan, the figurehead of the dollar, was trading at three times book in the late 1990s; I think he may return to book value.” Or lower.
Gold’s virtue, says Mr Grant, is that it is a monetary metal, because of its scarcity and, of course, its history. Actually, Buttonwood can’t help feeling, gold’s history counts against it. Of all the metals, the market for gold is probably the most rigged. It is because of history that central banks hold in their reserves almost a quarter of all the gold that has ever been mined. They would like to sell at least some of it, but the vast amount that they hold means doing so would drive the price down. In 1999, central banks therefore came to an agreement to restrict gold sales. The agreement—or cartel, if you will—was extended in September. But it would presumably be torn up if the gold price rose sharply: the Bank of France said this month that it wants to offload some 500 tonnes over the next five years.
And that would presumably limit gold’s upside. Perhaps a better argument can be made for other scarce metals: platinum, say, or silver. Silver, after all, not only spent centuries vying with gold as a form of money, but also has many industrial uses and is not held by central banks; annual demand is much higher than annual production. Along with many other metals, the price of silver fell sharply in April, but unlike gold it has not even regained the ground it lost. Also in its favour is that it is not exactly sold in industrial quantities at Claire’s Accessories.
All that glisters
Nov 30th 2004
From Economist.com
Is the rise in the price of gold merely the flipside of the dollar’s fall? Or does it point more broadly to a loss of faith in central bankers’ promises?
ALAS, the nearest that Buttonwood gets to visiting jewellery shops these days is a trip to Claire’s Accessories, a chain of fabulously tacky shops beloved of his daughters. To be fair, Claire’s (“Where getting ready is half the fun”) does not pretend to be anything other than cheap and cheerful. Nothing seems to cost more than £2.99. The jewellers in Bond Street, just round the corner from The Economist’s offices, are about as different from Claire’s Accessories as it is possible to get. The stuff in them costs rather more than £2.99. And their already steep prices have been going up because the prices of precious metals have been rising, gold’s not least. In the past week, gold has topped $450 an ounce, its highest level in 16 years—and up from a low of $253 in the late 1990s. What, if anything, does this tell us about investors’ faith in paper currencies.
The financial world, it sometimes seems, is broadly divided into those who believe in gold as the ultimate currency and those who don’t. In the latter camp are most economists, the most famous of whom, John Maynard Keynes, described gold as a “barbarous relic”. But even as late as the 1960s, Charles de Gaulle, then president of France, claimed that gold was the “unalterable fiduciary value par excellence”.
Gold or silver were money for most of human history, either directly or indirectly. Once paper currency was introduced, it was, in theory at least, backed by either of the two metals. Silver was gradually edged out as a monetary metal in the 19th century, from which time the “gold standard” reigned supreme. This arrangement, in its purest form, collapsed in the 1930s, but it continued in a bastardised form after the second world war, when America, which by then held three-quarters of the world’s gold reserves, again tied the dollar to gold, and the rest of the world’s currencies tied themselves to the dollar. In 1971, the dollar was forced off the gold standard because of mounting inflationary pressures. Since then the world has had so-called fiat currencies, which are backed by nothing more than the promises of central bankers and politicians that they will uphold the value of those currencies. Fans of gold—known as gold bugs—wonder whether those promises are worth the paper they aren’t written on.
They certainly weren’t in the early years. Inflation ate away at the value of anything with a fixed monetary value, and during the 1970s the price of gold rose from $35 to $850. But in 1979, Paul Volcker, then chairman of the Federal Reserve, stomped on inflation and the price of gold fell sharply. In its place came a bull market in the price of government bonds.
The dollar, it must be said, fared less well. It may have become the world’s reserve currency, even without the backing of gold, but it has been anything but a splendid investment, especially in recent years. While its internal value has not fallen as much as it once did, thanks to lower inflation, its external value—ie, in relation to other currencies—has been in remorseless decline, albeit punctuated by some longish rallies. In recent weeks, encouraged by malign neglect from American politicians and central bankers, the fall has shown signs of becoming a rout. As the dollar has fallen, so the dollar price of gold has risen.
It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world. Why, then, is gold prospering at a time when inflation is low? Perhaps it reflects nothing more than the fall in the dollar: gold transactions are denominated in dollars, and in euros the rise in the gold price has been anaemic.
However, there is no law that says a falling dollar must translate into a rising gold price. Apart from a rise in demand for jewellery, the rise in the price of gold may, at the margin, reflect demand for real, hard assets, as opposed to the paper sort. And the reasons are not hard to find, for across the developed world, debts have escalated alarmingly in recent years—and in America not least, hence the vast and growing current-account deficit. While central bankers are generally trusted not to “monetise” these debts by rolling the printing presses, history would suggest that this displays a touching naivety. As James Grant, publisher of an eponymous financial newsletter, and the most erudite of the gold bugs, says: “[Alan] Greenspan, the figurehead of the dollar, was trading at three times book in the late 1990s; I think he may return to book value.” Or lower.
Gold’s virtue, says Mr Grant, is that it is a monetary metal, because of its scarcity and, of course, its history. Actually, Buttonwood can’t help feeling, gold’s history counts against it. Of all the metals, the market for gold is probably the most rigged. It is because of history that central banks hold in their reserves almost a quarter of all the gold that has ever been mined. They would like to sell at least some of it, but the vast amount that they hold means doing so would drive the price down. In 1999, central banks therefore came to an agreement to restrict gold sales. The agreement—or cartel, if you will—was extended in September. But it would presumably be torn up if the gold price rose sharply: the Bank of France said this month that it wants to offload some 500 tonnes over the next five years.
And that would presumably limit gold’s upside. Perhaps a better argument can be made for other scarce metals: platinum, say, or silver. Silver, after all, not only spent centuries vying with gold as a form of money, but also has many industrial uses and is not held by central banks; annual demand is much higher than annual production. Along with many other metals, the price of silver fell sharply in April, but unlike gold it has not even regained the ground it lost. Also in its favour is that it is not exactly sold in industrial quantities at Claire’s Accessories.
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