Now, there’s a question, and it’s one that Societe Generale’s Dylan Grice has attempted to answer on Tuesday:
JP Morgan once said he’d made his fortune by selling too soon. We spend much time thinking about what to buy and when to buy it, when in fact knowing when to sell is more important. The case for owning gold is clear enough, but when should we look to sell?
His conclusion is not yet:
The reason I own gold is because I’m worried about the long-term solvency of developed market governments. I know that Milton Friedman popularised the idea that inflation is “always and everywhere a monetary phenomenon” but if you look back through time at inflationary crises – from ancient Rome, to Ming China, to revolutionary France and America or to Weimar Germany – you’ll find that uncontrolled inflations are caused by overleveraged governments which resorted to printing as the easiest way to avoid explicit default (whereas inflation is merely an implicit default). It’s all very well for economists to point out that the cure for runaway inflation is simply a contraction of the money supply. It’s just that when you look at inflationary episodes you find that such monetary contractions haven’t been politically viable courses of action.
Ultimately, the time to sell gold will only come, Dylan says, when heavily indebted governments face up to their problems and start taking their fiscal medicine:
The political winds in countries with central banks are a long way from blowing in the direction of fiscal rectitude. And while it’s true that more people are at least talking about it, talk is very cheap and no one is yet close to walking the walk. Such steps remain politically unpopular because we haven’t had our crisis yet. Given the clear unsustainability of government finances and the explosive path government leverage is on, a government funding crisis is both inevitable and necessary. and DubaiGreece are merely the first claps of thunder in what is going to be a long emergency.
Although that won’t happen any time soon:
But governments aren’t ready to take that step at the moment (the chart above shows just how painful the required measures could be). Indeed, the pressing fear among policy makers today remains that stimulus might be removed too soon. In the UK, policy makers refused to “risk the recovery we’ve fought so hard for” to quote PM Gordon Brown (“fought so hard for”!). In the US, lawmakers have just expanded the most inefficient health care system on the planet (according to ft.com there are five times as many CT scans per head in the US as there are in Germany, and five times as many coronary bypasses as in France). It has been promised that the increase will be deficit-neutral (which I doubt) but even if it is, current period deficits aren’t the correct way to look at health and pension obligations which should be examined on an actuarial basis (and if expanding the program is so difficult, wait until they try contracting it!).
But it will happen some day:
Eventually, there will be a crisis of such magnitude that the political winds change direction, and become blustering gales forcing us onto the course of fiscal sustainability. Until it does, the temptation to inflate will remain, as will economists with spurious mathematical rationalisations as to why such inflation will make everything OK (witness the IMF’s recent recommendation that inflation targets be raised to 4%). Until it does, the outlook will remain favorable for gold. But eventually, majority opinion will accept the painful contractionary medicine because it will have to. That will be the time to sell gold.
Related links:
‘Japan’s brewing fiasco’ – FT Alphaville
‘Some useful things I’ve learned about Germany’s hyperinflation’ – FT Alphaville
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