Friday, September 21, 2007

Gold Better Safe Haven Than Other Currencies

After Ben Bernanke in effect decided to lease just about every helicopter in America to flood the country with money -with a disproportione number of helicopters concentrated around Wall Street, of course-, an increasing number of people have finally started to realize that the U.S. dollar and interest bearing assets demoninated in the U.S. dollars sucks bad as investments. So they've decided to take their money into other currencies and interest bearing assets denominated in thoe currencies.

There is however a problem with that. Because public debate and central bankers in other countries are mercantilist in their nature, they will not react gladly to their currencies making new highs against the dollar. See for example here the complaints from exporters in the Euro area. And of course, Asian central banks are infamous for intervening to hold down their currencies.

The sharp increase in the euro makes more ECB rate hikes increasingly unlikely, as they know that further rate hikes would create further upward pressure on the euro. This means that inflation will get worse in the Euro area too. Similarly, the upward pressure on Asian currencies will likely increase their level of foreign exchange reserve accumulation which in turn will expand their balance sheets and so increase their money supply.

Thus, the more inflationary Fed policies will pressure other central banks pursue more inflationary policies to limit the increase in the exchange rate of their currencies. For that reason, it is unwise to rely on other central banks currencies as havens from Helicopter Bernanke's inflationary policies.

The only real haven is in real assets, including commodities such as gold. Stocks are in principle havens from inflation as the nominal value of their profits and fixed assets increase with inflation. However, if you believe as I do in stagflation, then most stocks will still suffer because of the cyclical downturn. The same thing goes with many industrial metals. Gold and some other noncyclical commodities are havens from both elements of stagflation-both inflation and recession. Stocks of producers of these commodities are also likely winners.


Blogger Flavian said...

I do, to some extent, disagree with you.

The fact that better currencies appreciate in real, inflationadjusted terms against the dollar, is causing many serious and good companies difficulties they would not face in a truly free market.

I also think that a good case for a remonetization of gold, is the fact that only gold can combine domestic stability with a low real exchange rate.

5:00 PM  
Blogger stefankarlsson said...

Well, of course the floating exchange rate systems big fluctuations in real exchange rates are creating distortions. That is why one should have a bias toward monetary unions in discussion of them compared to floating exchange rates.

However, as long as some parts of the world relies on inflationary fiat currencies and there is a difference in degree to the level of inflation, trying to recreate the exchange rate stability of a monetary union will for less inflationary countries by necessity require more inflation. Something which will create distortions in itself, distortions which I believe outweight the distortions from exchange rate fluctuations.

And that was my basic point in this point. The attempt to achieve exchange rate stability with a particularly inflationary currency will by necessity require more domestic inflation.

This would be even more evident for any country that would actually adopt the gold standard. Any attempt to maintain a gold stanard would by necessity presuppose the acceptance of significant decline in relative value of more inflationary -paper-based- currencies. Declines that almost certainly be uneven in its timing.

10:06 PM  
Anonymous Anonymous said...

Stefan... thanks for your thoughts, i am an avid reader of your blog.

What would be the effects if a country (say in the third world)decided to adopt the gold standard unilaterally? What would be the affect on domestic economic stability, growth, and the trade balance?


11:49 PM  

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