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Another Call for a Gold Peg from QB Partners

http://www.ritholtz.com/b…/adults-wanted/

Gold!
Creative Commons License photo credit: Martin Deutsch

As somewhat of a goldbug, I can’t help but enjoy reading the following updated article (See the original gold peg call from QB Partners posted in December 2008) from Paul Brodsky and Lee Quaintance, who run investment fund QB Partners. The article is posted on Barry Ritholtz’s Big Picture.

Gold at $3K/oz would be pretty incredible for current precious metal holders. Gold at $9,000? That is hard to imagine.

Yet if history is any guide, when we start seeing gold make a serious run up and everybody starts diving into the asset class, we could easily see some unbelievable prices reached.

The rebuttal is that all of this deleveraging will result in deflation, which will take down commodities and gold. With the Fed pulling all the stops, I don’t see that happening. They’ll overshoot on monetary policy (as always) and the resultant rice in prices will mean hell to pay (to buy anything!).

In our papers last year we established that an equilibrium price of gold (our “Shadow Gold Price”) would be something north of $9000/oz today. We used simple, Bretton Woods-model math (Federal Reserve Bank liabilities divided by US official gold holdings). To save the US and European banking systems and stabilize western economies we believe the US dollar peg to gold should be implemented at a much lower conversion price than its equilibrium price. The following actions should be taken:

1)The Fed announces a public tender for any/all outstanding private gold holdings at $3,000/oz.

2)The Fed prints Federal Reserve Notes (aka US dollars) to fund these purchases

3)As once privately-held gold flows into the Fed, the Fed’s balance sheet de-levers in gold terms

4)The Fed would soon own enough gold to credibly support the newly-designated peg

5)The Fed would also purchase the “people’s gold” currently held by the Treasury Department at the $3,000/oz clearing auction price (Treasury is carrying gold on its books at $42.22/oz.)

Bang – the soundness of the dollar suddenly becomes unquestioned because it has scarcity value. Its hegemony is protected and its status as global reserve currency is solidified.

A three-fold increase in the gold price should be enough to guarantee that the “free market” would drive asset prices up to the point that all toxic and opaquely-marked paper is once more reserved by banks at ratios greater than one. The loss that JP Morgan et al would suffer in their gold/silver short positions (yes we know about those) should be more than offset by the move to Par in all their respective paper assets. In fact, given the current interest rate structure of sovereign yield curves, we would argue that most dubiously-priced paper held by banks would be valued well in excess of Par, as credit spreads would collapse to reflect sharply higher asset collateral coverage ratios.

On an ongoing basis, the Fed would hold public auctions (as a buyer/seller) to maintain the $3,000/oz. peg. The gold market would become the new outlet for the Fed’s open market operations. Other economies would have to follow suit and devalue their currencies to preserve trade relationships (particularly net exporters to the US). This would be a huge transfer of wealth to the US, particularly from China and Japan. No doubt the US would have to negotiate terms with these exporters.

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The Money quote on Gold from Chris Wyke

http://themessthatgreensp…gold-price.html

Tim at TheMess has a fantastic quote from Christopher Wyke which, in only a few sentences, pretty much sums up the strength of gold as an asset class (I am unabashedly long gold, and this is not to be considered investment advice!).

Here’s Wyke:

Wyke: I think people have been investing in gold as a safe haven, as an alternative to stocks. But what’s really impressive is that the gold price is up by about 25 percent in the last four months at a time when the dollar’s been strong and no one’s been worried about inflation. I think, when that turns around, when the inflation concerns arise again, and if the dollar is to fall again, then gold could move very sharply ahead.

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Paul Volcker: “Not an Ordinary Recession”

http://www.ritholtz.com/blog/2009/02/paul-volcker/

Paul Volcker recently gave a speech that has gotten a lot of replay action on the blogosphere. I believe most are saying that Volcker is calling for a return to “narrow banking” (see Jesse).

A lot of people listen to Volcker as he led the charge at the Fed over taming inflation back in the late 70s and early 80s. I wonder more if he wasn’t just at the right place at the right time, doing what had to be done — raising rates. I’m convinced that most people give entirely too much credit both on blame and accolades. Don’t get me wrong, the Fed has enormous power, but my estimation is that they are almost always messing things up. The Fed is reactionary always and almost always reacts too far.

Therein lies the problem. The Fed fails at regulating. Hardly surprising, really. Is it not a joke to pay lip service to free markets, which are incredibly dynamic decentralized systems, and then use a central body to regulate the blood of the system, money? It’s a sad joke.

I could go on, but I’ll hold off. There are two pieces of Volcker’s recent speech I want to quote and comment on briefly. First:

One of the saddest days of my life was when my grandson – and he’s a particularly brilliant grandson – went to college. He was good at mathematics. And after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, “I want to be a financial engineer.” My heart sank. Why was he going to waste his life on this profession?

A year or so ago, my daughter had seen something in the paper, some disparaging remarks I had made about financial engineering. She sent it to my grandson, who normally didn’t communicate with me very much. He sent me an email, “Grandpa, don’t blame it on us! We were just following the orders we were getting from our bosses.” The only thing I could do was send him back an email, “I will not accept the Nuremberg excuse.”

There was so much opaqueness, so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events only happen once every hundred years. But we have “once every hundred years” events happening every year or two, which tells me something is the matter with the analysis.

So I think we have a problem which is not an ordinary business cycle problem. It is much more difficult to get out of and it has shaken the foundations of our financial institutions. The system is broken.

The system is broken. The system was too opaque. Finance is incredibly complex. It is here where I actually started wondering if Volcker “gets it” as far as understanding that our system is far from robust as centrally controlled and designed. As it is, Nassim Taleb is the only person I’ve seen who seems to glimpse the complexity of the financial system. However, I’ve seen even Taleb defer in theory to people “who saw this coming,” like Nouriel Roubini, for potential ways to “fix” the system.

Volcker’s comment about his grandson also hits home with me as I went into finance/accounting. When everyone you know is running into a field, that may be cause to rethink your choice of education (Everyone I knew in college was getting into Real Estate — this was back in 2001). Then again, I still wish I had gone and pursued computer science, but the dotcom crash (2000) scared me away.

More from Volcker:

What do I mean by different? I think a primary characteristic of the system ought to be a strong, traditional, commercial banking-type system. Probably we ought to have some very large institutions – or at least that’s the way the market is going – whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system. …

What has happened recently just underscores that. And I think we’re at the point where we can no longer fool ourselves by saying that is not the case. The government will support these institutions, which in turn implies a closer supervision and regulation of those institutions, a more effective regulation than we’ve had, at least in the United States, in the recent past. And that may involve a lot of different agencies and so forth. I won’t get into that.

So just as soon as I thought maybe Volcker “gets it,” he goes and says we should have a strong core (read: centralized) system of banking that is heavily regulated. He wants this core to be firewalled from entrepreneurial finance to eliminate conflicts of interest.

I’ll be brief. Regulation has failed. The Federal Reserve is a monstrous regulatory body that has repeatedly exemplified failure, and I’ve already mentioned its innate centralization. The SEC? Failure at every turn. More regulation? More centralization? How many examples do we need whereby larger organizations display a need for more regulation, and when more regulation is presented, said regulatory agency is either captured by the body it intends to regulate or is inept?

What we need are decentralized banking systems that are free enough and unencumbered enough to fix themselves or self-destruct without taking down the entire network.

The great centralization experiment has failed. Let’s move on (and follow the example of the internet, which exemplifies the power of decentralization).

Enough for now.

Update 2/24/09: Saw a youtube clip of Volcker’s speech. Wanted to get this quote down:

The description of a fat tail reflects a kind of analysis that isn’t appropriate. They think that financial markets follow normal distributions. pattern like the law of physics. The one remark I’ll leave with you: if you think the financial world follows a normal distribution pattern like the laws of physics. If you think that you’re a financial engineer but you’re not a very good financial analyst.

So he recognizes how inherently unpredictable financial markets are but then goes on to suggest that the Federal Reserve can fix imbalances that present themselves.

Cognitive dissonance.

[video:youtube:O3ROf8ln9rg]

@ http://www.youtube.com/watch?v=O3ROf8ln9rg

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Why Is This Bubble Different From All Other Bubbles?

http://jessescrossroadsca…t-from-all.html

Mostly interested in the latest Case-Shiller chart with the nice dotted line reversion to the mean. Based on the intersection point on the index, we can’t expect to hit a bottom on house prices until 2012, and then we would likely expect to overshoot a bit to the downside.

Takeaways include: expect house prices to fall further on a nominal basis, an inflation-adjusted basis, or both (likely both). This is information I’d almost rather not have as even if we don’t find a house in the next couple of months and relegate to renting for another year or so, we’re only marginally better off a year from now in the overall correction.

What can you do?

Here is the full-size.

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The Great Inflation Moderation that Wasn’t

http://themessthatgreensp…that-wasnt.html

Tim Iacono of The Mess that Greenspan Made consistently puts out some of my favorite charts, and has been doing so for as long as I remember (back before I was even blogging at autoDogmatic!). Anyway, his latest post is fantastic because it really attacks a huge misconception regarding the period of prosperity attributed to Greenspan known as the “Great Inflation Moderation.”

In particular, I love his chart below on Interest Rates and Existing Home Prices. I don’t know what was going on prior to 1980, but look at that inverse correlation!

And some quotes:

There are no real surprises below – a big run-up in prices as interest rates were moving lower over the last 25 years with a major price correction at the end that still has a little way to go.

It is through lower mortgage rates that dimwitted economists have sought to rationalize the dramatic rise in home prices over the last few decades, most of them thinking that everything was hunky-dory right up until the housing bubble burst in 2005-2006.

It’s no coincidence that, after the events of the last eighteen months, very few now see what was once glowingly called the “Great Moderation” as a permanent shift.

As far as price signals go, it was more like the “Great Muffling”.