An Embarassment of Riches, Part II
By Dr. Marc Faber
The Goldilocks protagonists will say, "Yes, consumption is a symptom of
economic strength." Personally, I think it depends on how consumption came
about. If it was achieved by the household sector selling assets and going
deeper into debt, then consumption is eroding the production capacity of a
country and will lead to impoverishment, as is indicated by the dollar's
loss of value.
The point is simply this: in the current expansion phase, which began six
years ago, the performance of the US economy and US asset markets in dollar
terms looks better than is the case in reality. What kind of an adjustment
we should make is debatable. It might perhaps be unfair to measure US GDP
and asset markets in gold, using as a starting point a very depressed price
level of gold as was the case in 2001. But even if we took a gold price of,
say, US$400 or US$450 (in the 1980s and 1990s, it seldom traded above
US$450), the recent performance of GDP and asset markets would be dismal.
Therefore, while the Fed can lower interest rates further and see to it that
asset markets stabilize - or even appreciate - in dollar terms, it is far
from certain they would increase in hard currency terms. So far, strong MZM
growth in the third quarter would rather seem to have boosted the
performance of emerging markets and of commodities. Also, whereas major
indexes have made new highs in the US, it should be noted that the majority
of shares have failed to make new highs. (Among brokerage shares, only
Goldman Sachs has made a new high.) As mentioned above, the strong rise in
the Nasdaq 100 Index (up 20% from the August low) was driven by a handful of
shares whose performance begins to resemble the performance of Chinese
stocks (see Figures 30 and 31)! In my opinion, there is much to lose from
buying these over-extended momentum stocks (including AAPL (NASDAQ:AAPL),
GOOG (NASDAQ:GOOG), AMZN (NASDAQ:AMZN), RIMM (NASDAQ:RIMM), WYNN (NASDAQ:WYNN),
etc.).
From my earlier reports and my thoughts above, one could reason that I am
very negative about the US dollar. This is certainly the case from a
longer-term perspective. However, we should also recognize that current
sentiment towards the dollar is very negative and that the Fed has some
power to force the European Central Bank (ECB) also to cut rates. Let us
assume that, because of additional rate cuts in the US, the Euro strengthens
further. At some point, the political pressure on the ECB will surely
increase and demand rate cuts in order to weaken the currency. The situation
in Asia is more complex. So far, Asian central banks have resisted their
currencies appreciating strongly against the US dollar. But with money
supply growing at around 20% in China and 24% in India, and with inflation
accelerating in Asia (in particular, food inflation), Asian central banks
may have no other option but to tighten meaningfully and let their
currencies appreciate against the US dollar.
However, as soon as their economies weakened or their over-extended stock
markets collapsed, monetary conditions would be eased very quickly. If this
were to occur, I suppose that the world would be left with only one currency
of total integrity: gold and other precious metals.
Consequently, if one were to bet on a continuous loss of purchasing power of
the US dollar and other currencies - a safe bet with respect to the US
dollar in the long term - my recommendation would be to own physical gold as
cash currency, which could also be bought in the form of an ETF (GLD).
I am asked constantly how gold would perform in a deflationary collapse.
With the propensity of the Fed and the ECB to flood the system with
liquidity and to take "extraordinary measures" whenever problems arise,
deflation is a remote possibility for the foreseeable future.
So, before worrying about deflation, I would worry about inflation
accelerating strongly in the years to come - especially if the US economy
stagnates. But let us assume that at some point in the future deflation
follows. What then? In my opinion, deflation could only be triggered by one
event: a total collapse of the existing global credit bubble. And the only
event I can think of that would trigger such a debt collapse would be a
third world war. The failure of a large bank - say, Citigroup - wouldn't do
the trick, because the Fed would immediately bail it out (unless Ron Paul is
US President).
Now, in a debt collapse, where would you rather have your money? In bank
deposits, in CDs, in dubious commercial paper, in bonds, in money market
funds - all of which would experience soaring default rates - or in physical
gold, ideally in a safe deposit box? I think that, particularly in a debt
collapse, physical gold would shine, as people the world over would become
extremely concerned about, not the return on their money (interest), but the
return of their money. This would be particularly true of Asian central
banks, which now have less than 2% of their reserves in gold but hold
massive quantities of all kinds of debt securities.
Consequently, while I find the gold price to be currently somewhat
overbought, I still think that gold will be one of the best investments over
the next couple of years. In particular, I would expect demand for gold from
individuals around the world to increase meaningfully - especially in Asia -
at a time when production is unlikely to increase. I wish to add that I am
not a "gold bug". I would much prefer to live in a world in which central
banks' top priority was to safeguard paper money's purchasing power and its
function as a "store of value". I would also much rather live in a world in
which the US dollar was a strong currency, and where America was as free as
it was in the 1960s, and the economic and financial imbalances weren't as
extreme as they are today. As Steven Roach recently remarked, "no nation has
ever devalued its way into prosperity". But the fact is, the time has come
when we can no longer trust central banks.
Therefore, each individual must be his own central bank and maintain
adequate reserves for himself in the form of physical gold. The supply of
paper money is potentially endless, whereas the supply of gold is very
limited. In fact, gold production from mines is declining.
Regards,
Dr. Marc Faber