Net Asset Values of Several Gold and Silver Funds and Trusts

A Theory of Great Depressions and a Confession from a London Banker

The London Banker has an interesting blog, and for some weekend reading we offer his latest piece on Irving Fisher's Theory of Economic Depressions, excerpt and link.

Mr. Fisher is a bit neglected these days, having made himself look the fool on the occasion of the Crash of 1929 and several times thereafter with optimistic pronouncements that in retrospect are incredibly embarrassing, severely tarnishing his reputation, perhaps deservedly so. but overshadowing some finer work in other periods of his career.

Is this perhaps why so many economists not in the employ of large trading houses and the government are so silent on the things that matter these days, with a few notable exceptions which will certainly be remembered favorably?

Nevertheless, the London Banker's views on this are worth reading, carefully and thoughtfully. It is a little disappointing in that he does not spend more time bringing Fisher's theory up to date. In particular, it is important to remember that Fisher was still thinking in terms of a currency constrained by an external standard for money, even though the dollar was substantially devalued in 1933.

We are seeing a replay of the elements which created the Crash and Great Depression complete with Fed policy errors and a complacent public, but played out under a purely fiat monetary regime. Exogenousl restraints may not limit the expansion of the dollar, providing new possibilities and variations on a theme. A brave New World indeed.

Those who are thinking of the scenario in which the US dollar gains in value during a debt deflation are imagining the dollar as a commodity rather than a currency.

As a commodity in short supply, they believe that the dollar will become more valuable because of some imagined constraint in its production by the Fed, tied to the creation of new credit. The average mind rebels at what a fiat currency actually represents.

They place too much emphasis on a fiat currency as a store of value, rather than its primary function as a medium of exchange. As a store of value the dollar is, and has been, and will be a wretched performer over all but the short term in special situations.

Another British economist Peter Warburton published in 1999 a more expansive view of this in a book that has become a cult classic, Debt and Delusion: Central Bank Follies that Threaten Economic Disaster.

In his April 2001 essay, The Debasement of World Currency: It Is Inflation, But Not As We Know It
Warburton noted:

"What we see at present is a battle between the central banks and the collapse of the financial system fought on two fronts. On one front, the central banks preside over the creation of additional liquidity for the financial system in order to hold back the tide of debt defaults that would otherwise occur. On the other, they incite investment banks and other willing parties to bet against a rise in the prices of gold, oil, base metals, soft commodities, or anything else that might be deemed an indicator of inherent value. Their objective is to deprive the independent observer of any reliable benchmark against which to measure the eroding value, not only of the U.S. dollar, but of all fiat currencies. Equally, their actions seek to deny the investor the opportunity to hedge against the fragility of the financial system by switching into a freely traded market for non-financial assets."


Thursday, 31 July 2008
Fisher's Debt-Deflation Theory of Great Depressions and a possible revision
The London Banker

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”.  John Stuart Mill

I have been both a central banker and a market regulator. I now find myself questioning whether my early career, largely devoted to liberalising and deregulating banking and financial markets, was misguided.

In short, I wonder whether I contributed - along with a countless others in regulation, banking, academia and politics - to a great misallocation of capital, distortion of markets and the impairment of the real economy.

We permitted the banks to betray capital into “hopelessly unproductive works”, promoting their efforts with monetary laxity, regulatory forbearance and government tax incentives that marginalised investment in “productive works”.

We permitted markets to become so fragmented by off-exchange trading and derivatives that they no longer perform the economically critical functions of capital/resource allocation and price discovery efficiently or transparently.

The results have been serial bubbles - debt-financed speculative frenzy in real estate, investments and commodities....

Fisher's Debt-Deflation Theory of Great Depressions and a Possible Revision - The London Banker

How Long Will the Recession Be?

Martin Feldstein is professor of economics at Harvard University, and is the current chairman of the National Bureau of Economic Research which makes the formal declaration on economic recessions in the US. He was the leading contender for the Federal Reserve Chairman along with Ben Bernanke of Princeton.

U.S. May Be in `Very Long' Recession, Harvard's Feldstein Says
By Kathleen Hays and Timothy R. Homan
Bloomberg News

July 31 (Bloomberg) -- The U.S. may now be in a ``very long'' recession that will drive the unemployment rate higher, with little that the Federal Reserve can do to help, said Harvard University Professor Martin Feldstein.

``I don't see recovery'' on the horizon, Feldstein, who headed the National Bureau of Economic Research until June and serves on the group's recession-dating panel, said in an interview with Bloomberg Radio.

Feldstein said the Fed has already lowered interest rates as much as it can to help growth, and that exports offer the only bright spot, while they aren't strong enough to fuel a recovery. A former adviser to President Ronald Reagan, he also warned that policies proposed by Senator Barack Obama, the presumptive Democratic presidential candidate, would prolong the downturn.

The next president ``should not be raising taxes,'' Feldstein said. He said he was ``really surprised'' that Obama ``hasn't backed off his proposals for a major tax increase.''

Feldstein said today's gross domestic product figures reinforced his view that the economy entered a recession in December or January. GDP shrank at the end of 2007 and grew less than forecast in this year's second quarter, the Commerce Department reported today.

Fed officials have lowered their benchmark rate to 2 percent from 5.25 percent since September, bringing the reductions to a halt in June amid rising concern that inflation will accelerate. Feldstein indicated the central bank should refrain from lowering borrowing costs further.

Fed Role

``I don't think that there's much the Fed can do one way or the other at this point,'' he said.

While Treasury Secretary Henry Paulson today said that the fiscal stimulus package enacted in February will keep helping the economy in the second half, Feldstein wasn't so optimistic.

``The little boost that we got from the tax rebates we will give up in the third and fourth quarters,'' Feldstein said. ``We're in for higher levels of unemployment and job losses.''

A ``typical'' U.S. recession lasts about 12 months, while the past two were about eight months, Feldstein said. This time, the slump may be longer, he indicated.

``If we do end up dating the recession as beginning at the end of last year, it could be a very long recession,'' he said.

Both Feldstein and Robert Hall, the Stanford University economist who leads the NBER's Business Cycle Dating Committee that determines U.S. recessions, said it was too early to gather for a formal declaration....

How Much Farther Will the US Dollar Decline?

The short answer is that the dollar will continue to decline in relation to the currencies of its trading partners until it starts generating a trade surplus. As the dollar loses its status as the reserve currency of the world this process will accelerate.

This decline will not be uniform. The Euro may have already achieved much of its appreciation, with the Asian currencies and those of resource exporting countries lagging significantly.

The process will be slower to the extent that the world is willing to subsidize US consumption by treating the dollar as a reserve currency with inherent value greater than their own currencies. This is how the trade surplus was allowed to remain negative for so many years.

The price of imported natural resources such as oil will provide a significant lever in the dollar's decline.

Note that there is no discussion of domestic money supply growth or contraction per se, only the flow of currencies between and among countries. The issue of money supply becomes relevant through its effect on the interest rates, and the interest rate differentials.

This is not a metaphysical debate; this is math. Unless the rest of the world wishes to allow the US to be its sovereign lord and master, the dollar has a significant distance to travel on its long day's journey into night.


What is the Dollar’s Sustainable Value?
By Martin Feldstein
July 31, 2008

How much further will the dollar fall? Or has it already fallen so far that it will now start to move back to a higher level?

For travelers to the United States from Europe or Asia, US prices are dramatically lower than at home. A hotel room or dinner in New York seems a bargain when compared to prices in London, Paris, or Tokyo. And shoppers from abroad are loading up on a wide range of products before heading home.

But, despite this very tangible evidence, it would be wrong to conclude that US goods are now so cheap at the existing exchange rate that the dollar must rise from its current level. Although the goods and services that travelers buy may cost less in the US than abroad, the overall price of American products is still too high to erase the enormous trade imbalance between the US and the rest of the world.

To be sure, the falling dollar over the past few years has made American products more competitive and has caused the real value of US exports to rise sharply – by more than 25% over the past three years. But the trade deficit in 2007 nevertheless remained at more than $700 billion, or 5% of GDP.

The large trade deficit and equally large current account deficit (which includes net investment income) implies that foreign investors must add $700 billion of US securities to their portfolios. It is their unwillingness to do so at the existing exchange rate that causes the dollar to fall relative to other currencies. In falling, the dollar lowers the value of the dollar securities in foreign portfolios when valued in euros or other home currencies, shrinking the share of dollars in investors’ portfolios. The weaker dollar also reduces the risk of future dollar decline, because it means that the dollar has to fall less in the future to shift the trade balance to a sustainable level.

But what is that sustainable level of the trade balance and of the dollar? While experts try to work this out in terms of portfolio balances, a more fundamental starting point is the fact that a US trade deficit means that Americans receive more goods and services from the rest of the world than they send back – $700 billion more last year. The difference was financed by transferring stocks and bonds worth $700 billion. The interest and dividends on those securities will be paid by sending more “pieces of paper”. And when those securities mature, they will be refinanced with new stocks and bonds.

It is unthinkable that the global economic system will continue indefinitely to allow the US to import more goods and services than it exports. At some point, the US will need to start repaying the enormous amount that it has received from the rest of the world. To do so, the US will need a trade surplus.

So the key determinant of the dollar’s long-term value is that it must decline enough to shift the US trade balance from today’s deficit to a surplus. That won’t happen anytime soon, but it is the direction in which the trade balance must continue to move. And that means further depreciation of the dollar.

An important factor in this process will be the future price of oil and the extent of US dependence on oil imports. In each of the past four years, the US imported 3.6 billion barrels of oil. At the current price of more than $140 a barrel, that implies an import cost of more than $500 billion. The higher the cost of oil, the lower the dollar has to be to achieve any given reduction in the size of the trade deficit. So a rising oil price as measured in euros or yen implies a greater dollar fall, and therefore an even higher oil price when stated in dollars.

There is one further important consideration in thinking about the future value of the dollar: relative inflation rates in the US and abroad. The US trade deficit depends on the real value of the dollar – that is, the value of the dollar adjusted for differences in price levels in the US and abroad. If the US experiences higher inflation than our trading partners, the dollar’s nominal value must fall even further just to maintain the same real value.

The inflation differential between the dollar and the euro is now relatively small – only about one percentage point a year – but is greater relative to the yen and lower relative to the renminbi and other high-inflation currencies. Over the longer run, however, inflation differentials could be a more significant force in determining the dollar’s path.

Martin Feldstein, a professor of economics at Harvard, was formerly Chairman of President Ronald Reagan’s Council of Economic Advisors and President of the National Bureau for Economic Research.