Through TheFLY's Eyes: Gold
Economics 101: S = I
One of the first concepts learned in economics is that savings equals investment. However, from looking at the long-term price chart of gold, it looks like savings equals inflation. The US exited World War II with debt as a percentage of GDP at 125% and inflation was nil. In 1979, debt as a percentage of GDP was 36%, its lowest level in the post-World War II era and inflation was going through the roof.
Let's look at the world today. Despite cries that the US doesn't save, individuals are sitting on some $5 trillion in cash in money equivalent-type of instruments. India, holding its recent meeting with the Bush Administration, boasted that its savings rate is 30%. China simply says its savings rate is over 20%. 20% tends to be the norm for many economies, but many suspect that China's savings rate is much higher.
US corporations are flush with cash. During the first part of this decade, it was the first time since the 1960's that US companies did not require external sources of financing to fund internal expansion, they generated so much cash, they were self funding.
Post the 1998 emerging market meltdown, virtually every economy is less dependent on debt financing and swimming in cash. And guess what is happening: The price of GOLD is going through the ROOF.
In recent history, gold was its cheapest from 1998 to 2001, when savings were low and many economies were restructuring their balance sheets. This was probably the biggest mistake during Greenspan's tenure, he continued to raise rates in 1999 while gold was telling him that deflationary pressures were greater than inflationary pressures. Gold was correct.
Where are we today?
History tells us that when human beings have too much money, they do dumb things with it. The primary of which is paying too much for homes to cars to food, etc. Savings today around the globe is enormous (an economics professor's dream), but that means there will be a lot of dumb decisions made. History has shown gold has been a good place to hide when poor decisions are made with money.
With excess savings, there are two ways to reduce its power 1) let inflation eat away at it over time like we did in the 1970s which led to a very difficult time for the world or 2) contract the amount of money in the economy. The US has increased rates from 1% up to 5%, so it has been attempting to do its part. The real questions is are the emerging markets doing their part? The price of gold is suggesting that maybe they are not.
Despite the massive swell in savings after the Asian meltdown, gold is telling the marketplace that savings might have gone to the other extreme. Sometimes too much savings equals inflation.
Wednesday, May 10, 2006
Through TheFLY's Eyes: Gold