Will the Real Driver Please Stand Up: Keynes is Dead, Long Live Keynes
Below is an extract from a commentary available to subscribers at www.goldenbar.com on May 17, 2006.
With respect to the oil or gold market, or markets in general, I don't think I could add anything of value to what is already imputed to the evolving situation in Iraq, Iran, North Korea, Darfur, and so on. Some risk of conflict breaking out prior to the end of Bush's term has probably already been factored in gold and oil markets; and it is probably here to stay for as long as he stays in office, regardless of what happens next. In fact, perhaps it should be called the GW premium for the brilliant insight that this war on terror was winnable at all...
But the war premium is not driving this market, at the moment anyway.
The driver at the forefront of this thing is the global monetary explosion and investors are only beginning to know it. The initial reaction of the gold market to news that the Chinese central bank was raising its policy rate on April 27th (its second 25 basis point blip since the rate bottomed at just above 5% in 2004) compared with the market's initial reaction to the news the weekend before last that Iran made an attempt at diplomacy with the United States over the nuke issue perhaps attests to this. In the former situation gold prices dropped US$15 on the COMEX when the news hit; in the latter situation gold prices dropped just 10 bucks. This phenomenon was even more apparent in copper and the CRB. [The market brushed aside both events however; as it turned out, the letter did not debunk the fear of a war (it was seen as an incoherent last ditch PR gambit by a desperate regime), and fears of further tightening by the Chinese central bank abated quickly enough.] Notwithstanding, the knee-jerk bearish reaction to the monetary news was more intense than its reaction to geopolitical stuff.
The market's reaction to last week's news on China's plan to accumulate commodities underscores this further.
Certainly, the growth of US money supply has slowed over the past few years, but, aside from questioning the significance of such a transitory phenomenon, the rate of growth in the monetary aggregates of the other central banks continues in the high single to mid double digits - usually faster in narrow money than in broad money.
Now, I do not put a lot of faith in any central bank data (even the monetary statistics (M1, M2, etc.) themselves aren't technically correct) to begin with, so I take data from the Chinese central bank with a giant grain of salt.
According to Frank Shostak, however, the Chinese central bank's balance sheet has been growing at incredible rates: "After falling to negative 1.2% in March 2001 the yearly rate of growth of the central bank balance sheet (monetary pumping) relative to real economic activity climbed to 28.2% in September 2005. In February this year the yearly rate of growth of the relative pumping stood at 22.1%. In contrast, the yearly rate of growth of the Fed's balance sheet in relation to real economic activity fell from 11.6% in September 2001 to 0.9% in March." [Source: http://www.mises.org/story/2134].
The point is that whether people "see" it or not, inflationism is what's really driving commodity demand out of China and every where else. Consider the growth in the monetary aggregates generated by some of the main (G7) central banks over the past two decades in the table to the right (the table uses M1 and M3 in most cases, except for the US where I've substituted MZM - which is a better if inadequate category of broad money than M3 which was discontinued in March).
If you're going to inflate the hell out of your money supply and fix your currency on the foreign exchange markets, as China does, the importation of commodities or other goods suddenly becomes a very profitable enterprise because it allows the inflating country to buy commodities on the world market with currency that is overvalued by virtue of its peg to a less inflationary currency, and then sell them domestically (i.e. in China) for higher prices in the local overly inflated currency.
China isn't the only country guilty of such an exploitive policy, but what I want to stress is that this commodity boom is chiefly a monetary phenomenon. It is stoked by the facts in the table above, and in some cases, like in China's case, it is also stoked by an interventionist mentality. The extra demand on the world's raw materials arising from the building of a capitalistic "infrastructure" in China, or Russia, or India, would be more incidental were not for the inflationary and interventionist propensities of those countries. Yes, this means that if China didn't inflate and the state didn't step up its strategic accumulation of commodities plan, it wouldn't be such a story for the commodity boom. All the talk about real economic growth, whether here or overseas, as causing the commodity boom through the wealth effect or the concept of aggregate demand is absolutely erroneous.
Keynes is dead, and his ideas died long before he. Some market mavens, rather than accepting the inflationary fact, have taken to blaming gold's rally on this concept of "hot money." I'll tell it like it is: a load of crap. It is a euphemistic buzz word for the word "speculation" that the Soros wanna-be hedge fund crowd has caught on to.
Moreover, when one talks of a lot of money sloshing around as "hot money" on the one hand, while another as "liquidity," and yet another as "savings," rather than what it really is at most - excess inflationary fiat - you know one thing: they are either anti-gold, pro government, or they do not understand gold or economics. The inflation and intervention concepts are THE driving forces of the commodity bull market generally and gold specifically.
They always have been (inflation is a form of intervention, indeed the largest besides direct taxation).
"It is always an inflationist policy, not economic conditions, which bring about the monetary depreciation. The evil is philosophical in character" - Mises on the Manipulation of Money and Credit p. 48
The value of money is really falling whether the CPI says so or not. And all the markets are increasingly acting in accord with that fact - i.e. higher stock and real estate prices across the board (particularly in the inflation sensitive sectors) are increasingly accompanied by higher interest rates across the yield spectrum.
Gold has been somewhat of a laggard among the metals but a leader compared with the other commodities for much of this rally that has spanned the appointment of Ben Bernanke and several other newbies at the Fed.
So although the bull is still somewhat stealth among the metals, and the non-monetary themes most dominant among traders, I believe the markets are beginning to move in our direction - to the monetary facts as such.
There are signs that market's focus is evolving to the monetary fundamentals of the Federal Reserve (near and long term) - helped by Bernanke's waffling over the Fed's rate hike campaign - reflected by the attitudes of major dollar hoarders towards the USd, in the talk and surrounding buzz of a Chinese plan to accumulate gold, and the demand for gold and silver ETF's in particular.
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