Yes this is Zapata George at his best. George passed away in 2010.
Lesson #2 – Zapata’s 5 rules of investing. HNNC, Study History to Learn, The World Runs on Oil, TOM is G, Fundamentals Will Rule Out …eventually.
His first lesson highlighted some other investment issues and economic facts which he indicated came from a Warren Buffet interview in 2002 with Fortune Magazine.
Of course if interest rates stay low and remain flat we could see stocks rise even though GDP growth is low, as retail investors try to catch up to the gains the smart money already made from moving out of bonds and into stocks. So did QE also support this smart money move by keeping interest rates down as bonds were swapped for stocks ?
The real issue is how soon will interest rates trend higher ?!
I have been taking the INET course on Money and Banking by Perry Mehrling. It is a superb course and has introduced me to this concept that the financial/monetary system requires elements of elasticity and discipline to live.
In Lecture 14 of the course he introduced why the Keynes concept of the Bancor (more elastic system) was trumpted by the SDR (more disciplined system) concept for creating this higher level of money in the hierarchy between gold and national currencies and this post is being made to capture that idea. In fact he occassionaly shows Gold and SDRs (paper gold ?) as being equivalent but that is another future discussion!
Of course the BANCOR favoured the deficit nations since it provided for no limit on any required monetary system elasticity (bank of last resort) and dealt with the asymmetry issue of rebalancing the global monetary system by actually charging the surplus nation a negative interest rate so that they would spend the money. Perry’s arguement was that the US looked at the Keynes model and concluded that since they expected to be the major surplus nation that this concept was not really in their better interests. Hence it did not happen.
Instead what ultimately developed was a paper reserve called the SDR (Special Drawing Rights). It was more like a gold standard in that there would only be a fixed quantity created. SDRs would have the qualities of a more disciplined system and would benefit the higher GDP nations as opposed to the emerging nations because in the new IMF model the highest GDP nations (read USA) received the biggest share of the SDR allocations (paper gold) being created. That way all those SDRs allocated to the USA could be loaned by the USA to deficit developing countries when needed ?!!
Today the USA is the major deficit nation but continues to receive the largest allocation of SDRs. No surprise that China is fighting for a different system !? The SDR is hence not disciplined or elastic enough in it’s current construct. So what is the future ? Some say it is adding the RMB to the SDR basket of currencies and increasing the number of SDRs allocated to nations ?
Of course Perry Mehrling indicated that the entire gold standard system could have been saved (at any time since the 1920s) by simply revaluing gold to a higher price ! Is that still part of the ultimate fix ? Gold priced higher as the discipline and maybe a BANCOR like currency (not based on any nation’s currency) as the next layer in the new hierarchy of money ?!
Central banks don’t directly take their bullion to the market and lease it out. They use a vehicle called a bullion bank (BB). Although bullion banks are numerous, some of the more well known are Barclays, Goldman Sachs, JP Morgan, Bank of America, UBS, and Citibank. The central banks loan gold to the BBs at a rate of approximately 1%. The BBs take it to the LBM and sell it on the open market. The BBs take the cash from selling the bullion and in turn buy Treasuries.
So if the story were to end here, the bullion banks would just walk away with a net 4% return. But it doesn’t end, because they only have the leased gold for a certain length of time. They eventually have to give the gold back to the central banks, but now they are at risk of price swings in a very volatile market.
The answer to their problem is to go long the futures market. Essentially, they buy futures contracts to hedge their risk. In other words, they secure gold for delivery at a specific price, on a specific date in the future. Once they buy their futures contracts, it doesn’t matter what the price action of gold is.
Now in a declining future gold price market this Leasing Out of Gold no doubt generated easy profits. In todays rising gold markets does it become more problemmatic? Maybe because the gold futures potentially will cost more to purchase and the treasuries are providing significantly less percentage return.
However observe that the FED is actually loaning out gold at a negative interest rate ? What ? Is this an error ?
So does the rising gold price not also allow the Bullion Banks (BB) to take increased cash out of the economy and with it buy increased government bonds?! It would actually appear that a “steady” rising gold price might be desired to accomplish just that?!! But why? Maybe to help soak up those excess reserves ? And the FED is paying negative interests to the BB to borrow gold and play this winning game !