The financial crisis began in 2008, that’s coming up to 5 years ago and the fallout is still being felt. The two most recent events to illustrate this are the Japanese embracing of QE and the historic fall in gold prices.
Taking the Japanese situation first.
Japan is the world’s third largest economy; post the Second World War it reaped the loser’s dividend as did Germany and boomed, becoming an export powerhouse and by the mid 80’s the US became seriously concerned that the Japanese were in the process of buying it.
They had huge trade surpluses and used these, particularly dollars, to acquire US real estate and treasury bonds (pay cheques on US future income).
Its own real estate market became hugely expensive, illustrated by the calculation that the notional value of the Emperor’s palace in Tokyo was greater than the combined value of all the property on the island of Manhattan.
Fast forward twenty five years however and the landscape had changed completely.
The bursting of the Japanese real estate bubble in the late 80’s effectively bankrupted its banking system but rather than write down losses, the Governments allowed zombie institutions to meander on lifelessly.
Japan’s cultural differences in comparison to the West (for a time so important in its success) became a source of its subsequent atrophy; its employment practices preventing downsizing, its concern with loss of honour (face) causing mistakes and failures to be denied, hidden and ignored.
Added to the above was and is the ticking time bomb of its demographics; Japan has an ageing and falling population, the costs of healthcare and retirement rising with ever fewer young people to subsidise the costs through tax revenue.
Whilst Japan still has a trade surplus (it sells more than it buys) its debt to GDP (gross domestic product) is over 200%, to put this in context this is far far higher than Greece (about 140%).
All of the above was difficult enough but the problems did not stop there.
The Japanese central bank being very conservative made no attempt after their real estate crash to create liquidity in its economy. The actions of Ben Bernanke and the Federal Reserve post 2008 were fundamentally informed by two past events: the Great US depression of 1929 and the Great Japanese deflation of the past 25 years.
What could be clearly divined was, “don’t let Banks fail” (Great Depression) and “don’t let the economy deflate” (Japan).
The bank lesson is pretty self-evident; if one bank fails the system fails because the first acts like a domino, knocking over most if not all the rest. It will be a debate for the ages as to whether Hank Paulson’s decision to allow Lehmann’s to fail was the lesson everyone needed to learn or Russian roulette with five bullets in the gun. It very nearly proved fatal but the power of the lessons learned cannot be overstated, it’s highly doubtful that the Fed truly understood the systemic risk it was taking but it turned out ok (and history is usually written by the victors).
Ben Bernanke’s nickname “helicopter Ben” emanates from his comments post-crash that he would drop as many dollar bills from a helicopter as necessary to ensure that the US economy maintained liquidity and did not deflate.
What does he mean by this?
The lessons from the fundamentally similar Japanese situation were:
Real estate booms, banks and households assume larger and larger debts secured against these rising values and whilst this is in process everybody feels great.
Banks make huge profits, individuals feel richer and spend more because of this, the economy motors along merrily and all is rosy.
Like a pendulum however once the momentum reverses, all the formerly positive actions and reaction invert.
Banks suffer huge write downs and stop lending, individuals go into negative equity, feel poorer and stop spending and prices are locked into a downward spiral exacerbating the situation ever further.
The Japanese central bank reaction to this scenario was fundamentally to do nothing, the result being that the liquidity dried up and the economy started to deflate.
Deflation is a killer, if an individual can see that what they want to buy will be cheaper next year than now they defer consumption, which in turn causes consumption to fall overall, leading to more deflation, in short a death spiral.
Fast forward to 2012, the Japanese had watched the US go through its housing crash and financial meltdown and had seen it employ QE, that’s to say the Federal Reserve had flooded the economy with new money to offset the deleveraging of banks and households and its economy had avoided stall speed (no deflation).
Japan has now embarked on its own massive QE, explicitly stated it will lower the value of the Yen, buy huge amounts of JGB’s (its sovereign bonds) and target an inflation rate of 2% (inflation will cause consumption to increase just as deflation causes it to fall). It was the ultimate irony that the Yen had been seen as a safe haven post 2008 and its relative value had risen significantly, many people had questioned how this could be so with Japan facing the problems it did but the answer seemed to be somewhere in the vicinity of, yep they’re screwed tomorrow but most of the others are screwed today!
What does this all mean?
Simplistically it means that investors currently have that most glorious of things, a one way bet!
They know that the yen will fall, they know that massive amounts of money is going to inflate asset prices (equities) and they know that the best multinational Japanese companies will profit significantly from a falling yen.
As we have written before gold is a conundrum wrapped in a riddle in a darkened room with a black cat that actually isn’t there.
It has no utility it costs a fortune to dig up and another fortune to guard.
It produces no dividend and it doesn’t expand or develop.
But…. it’s been generally accepted as a store of value from the earliest times (Egypt and on). It doesn’t deteriorate, it’s rare, can’t be debased unlike currencies which can be printed infinitely and it’s shiny and pretty.
So the rise in gold over the last decade is understandable when many feared the breakdown of economic and social order.
Added to this fear has been the zero interest rate environment which made holding gold a “no cost” option; if interest rates are say 4% the lost yield of holding gold as opposed to a gilt or Treasury note is 4% an investor therefore has to believe that gold will rise on average by at least 4% annually, so a guarantee with a bond is a hope with gold. If cash equivalent returns are at close to zero then holding gold does not require investors to forgo income.
The difficulty with valuing an ounce of gold is simply how do you do it?
A company can be valued by its assets, current and projected future profits, not an exact science but fundamentally a science.
Gold has none of these valuation metrics, the main metric seems to be what is the price, what was the price in the past and is the current price above or below in real terms blah blah silly silly blah.
To put the proper context to this subject it is true that there are many intelligent people who are advocates of gold investment. It really is a faith based argument, you either believe or you don’t but if something’s worth is predicated on it being rare (although not useful) and indestructible then would this not equally suggest that people invest in Captain Scarlet! (Who is useful!)
The big move down in gold is possibly an example of the momentum of trading an asset inverting, on the way up more people jump on board to make quick money, going down they all jump off.
It only strengthens the argument that the science of investing is in establishing a fundamental value for any asset and then purchasing when price significantly below it, which must over time yield positive returns.
So with gold there is no way to establish intrinsic or fundamental value, even to argue ‘it’s the mining cost’ seems anomalous, are we saying that the value of something, anything is at least what it takes to produce; try building and selling for a profit a £5 million house next to a busy airport to test out that theory.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.