"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value." – Alan Greenspan (before he converted to the "other side")
The US, as was to be expected, raised their debt ceiling once again. It was done without meaningful cuts in spending or tax increases. Subsequently, Standard & Poor's downgraded America's credit rating. The double dip recession in America is now official, with dismal economic indicators and the consumer price index rising. The stock markets are reacting accordingly. Meanwhile, European leaders, primarily Merkel and Sarkozy, are giving frantic lip service to solving the debt crisis and saving the Euro without decisively taking a stand.
Of course, the REAL AND CORE BATTLE revolves around the world's fiat currencies with the Euro and the US dollar at center stage. As I started writing this commentary, it was the morning of August 17th. Precisely forty years ago, US President Richard Nixon ended the gold standard and announced the end of the Bretton Woods International Monetary System. Either knowingly or unknowingly, he unleashed the fundamental ingredients of the toxic monetary and fiscal waste the world is dealing with today.
Nixon's announcement, no matter how many times you have already seen it, is worth watching (again) with the benefit of 20/20 hindsight and in the context of current developments – although his reasoning does trigger a bit of nausea in me.
Forty years of "easy money" coming to an end
Since 1971, the progression of decreasing interest rates and increasing debt in western societies has been a steady one. The world has witnessed a variety of business cycles and a number of financial market crises over this period. The one common denominator throughout has been increasingly loose monetary and fiscal policies.
These policies were the reason for the sub-prime crisis and the crash in 2008. And, these policies are the reason we are headed for the worst economic downturn since the 1930s, with all the ramifications and implications that will come with it.
Largely, the recipe for each of these crises was "mo' money," à la Keynes. This recipe was once again pulled out of the drawer in 2008 and has been kept in hand since. Despite the obvious growth of debt and deficits, and the heightened risks that should be expected to come with them, Europe and America have enjoyed comfortable AAA ratings, increasingly low interest rates and cheap access to "risk-free" financing.
The results are well-known. Monetary inflation, over time, leads to market imbalances and pricing distortions. Easy money results in large-scale capital misallocations, asset bubbles and too much debt – public and private. Today, the bill is being presented and served. The non-gold-backed global fiat currency system is losing the world's confidence and trust. It is coming undone, and quickly!
John Maynard Keynes is often quoted on his perspective regarding the long-term results of monetary inflation. He said: "The long run is a misleading guide to current affairs. In the long run we are all dead." Mr. Keynes was right. It's been a long time since he made this statement, and Mr. Keynes has passed away since. However, we are living in a different time and, for us, the long run has arrived. It is NOW!
Keynes was an economist who understood the ultimate consequences of long-term excessive monetary inflation. He also understood the fact that the single most important and fundamental requirement for political and economic liberty and prosperity is SOUND MONEY. As soon as people hand over the exclusive and unlimited power of money management to governments and banks, they give up sound money. And with it, they give up all of their core powers to the state.
Two safe havens in high demand: the Swiss franc and gold
Today, as the two leading global fiat currencies are depreciating at breakneck speed, investors around the globe are looking for safety. To a large extent they are putting their money into the Swiss franc and gold.
Gold, without question, has been the best investment over the past decade. As of late, the only paper currency that has been relatively strong versus gold has been the Swiss franc.
When a currency becomes "TOO STRONG"
The Swiss franc continues to prove its safe haven status. As investors, both sovereign and individual, seek safety in the Swiss franc, its exchange rate versus the US dollar and the euro has been skyrocketing. The franc hit all-time highs against the euro and the dollar last week as investors sought safe assets amid market turmoil and fears about government debt.
Swiss exporters and the domestic tourism industry have both suffered as the price of goods manufactured in Switzerland and the cost of visiting the country has risen sharply.
Over the past few weeks, the Swiss National Bank (SNB) has become active in both word and action. After record highs against the US dollar as well as the euro, the Swiss currency is now widely considered highly overvalued. Thus, a mire of announcements and actual intervention has been launched. So far, they have had a very limited effect and it appears as though the SNB is beating a pillow.
One aspect that appears to go widely unnoticed is the fact that while the Swiss franc is globally well established as a safe haven currency, it is by no means a currency that in terms of size and circulation can be compared with the US dollar, the euro or the yen. The balance sheet of the SNB is relatively minute compared to those currencies. Thus, the interventions available to the SNB are very limited.
The measures taken thus far by the Swiss National Bank (SNB) against the strength of the Swiss franc are having some impact. However, the Swiss franc remains strong. The SNB has therefore decided to expand again significantly the supply of liquidity to the Swiss franc money market. In so doing, it is increasing the downward pressure on money market interest rates with a view to further weakening the Swiss franc exchange rate.
As a result, Swiss swap rates have turned negative. The three-month overnight swap rate for Switzerland fell by 7 basis points yesterday to minus 14 basis points, suggesting that investors expect the Swiss National Bank to implement a negative interest rate policy by November. The decline in the swap rate came after the central bank reiterated "it will, if necessary, take further measures against the strength of the Swiss franc."
I don't like the look or smell of this at all. First of all, I doubt whether the SNB will have any meaningful impact. In the world of fiat currencies there are no 'good' or 'bad' currencies. There are only 'better' and 'worse' currencies. I doubt the SNB's interventions will be able to turn the Swiss franc, a 'better' currency, into a 'worse enough' currency to be even less attractive than the euro or the US dollar. The fundamentals of Switzerland are too strong, or more importantly, the fundamentals of the US dollar and the euro are too weak…
Secondly, I am concerned that the objectives these loose monetary policies are supposed to achieve, namely to support the Swiss economy in a time of currency-mania, may in fact harm the economy badly. It is conceivable that inflation could pick up quickly with these kinds of policies.
These policies could very quickly ignite inflation in Switzerland, which will force the SNB to raise interest rates at a time when the recession hits the country. And, a recession will hit the country for sure as the rest of the global economy goes into stagflation. The Swiss National Bank, in my opinion, would be better off doing NOTHING at this point and keeping a keg of dry powder handy instead of wasting it before the real battle begins!
Where do we go from here?!?!
I think that the Swiss franc will stay relatively strong. It may retract temporarily. However, it will retain its safe haven status no matter what the SNB does, unless of course Mr. Hildebrand and his SNB colleagues intend to destroy the currency together with the rest. That, however, is not the case.
For you Mountaineers, all the hype and the market gyrations should not present any sleepless nights. If you have followed our recommendations over the past months, you are well-positioned to cope with and benefit from the latest developments. Certainly, gold is performing as expected. I expect it to go much higher as markets recognize that, at most, the US and European governments are playing their usual smoke-and-mirror charade.
The emperor's clothes have been recognized for what they are: nothing but fluff and hot air. Particularly the US economy and its currency are hitting a wall. The euro is in a better position, in my opinion, assuming that Merkel & Co. decide that the euro's time has come as the number one world currency – at least for a while.
As far as the Swiss franc goes, as mentioned, I think it will remain a 'better currency.' However, beware that currency markets are highly volatile and, as many investors know who had bet against the dollar in 2008, a market correction with rapid and large-scale de-leveraging could send the US dollar on a steep (albeit temporary) rally. At BFI, we have hedged our clients' portfolios against that kind of move. We recommend you consider doing the same.