AlexisW | 
02 24th, 2009| 
Gold has rallied above $1000 per troy ounce on Friday before slipping back in recent trade. Gold is the oldest financial commodity and is traditionally a safe haven in times of crisis. It is the only financial asset that doesn’t represent an obligation by somebody else. No need to worry about Ponzi schemes. While the price surge could represent further safe-haven investing with the threatened nationalisation of Citicorp and Bank of America, it may also indicate that investors may finally be pricing in the only way the develop world is going to get out of this mess. Inflation. There are problems in asset markets, with houses supposedly worth more than people can afford to pay. There are problems in financial markets, with many bank fundamentally insolvent as their paper assets collapse. There are problems with the money supply, as the shadow banking system and credit collapses as bank retrench their balance sheets. There are problems in the real economy, as investment collapses from a lack of funds and a lack of confidence, and as employment falls as businesses cut costs in advance of the recession. As employment falls, asset values seem more overvalued and the downward spiral continues. Thus while the mess started in subprime, it will keep on getting worse until people decide to take risks again, by borrowing and lending.
The key problem for the real economy is monetary. As people reduce their debts, someone somewhere else is reducing their financial assets. The money supply gets smaller and the level of economic activity declines. Now that interests have nowhere to go governments are starting to increase the money supply with ‘quantitative easings’. Ultimately if you print enough money, debts will decline and asset prices will seem reasonable again, bringing the crisis to an end. To do that takes inflation, against which gold is the oldest hedge.
Alexis Wadsley
Alexis_W@utas.edu.au