Gold Economy

Have you ever wondered why the gold prices, at their all time highs, are still rising? Perhaps some people have a clue.

Last November, in a majestic, colonial style corner office in Fort, Mumbai, I met a visionary and an infectious investment officer of a large investment company. His whole office set-up, with large pillars of books and sheaths of notes reminded me of ‘John Nash’ as in the movie - ‘A Beautiful Mind’. The company runs on Berkshire Hathway model and we discussed at length the apparent reasons for the collapse of the Global Economy. Of course the reasons came out to be relative inadequacy of the valuation models to model out scenarios of liquidity squeeze or any similar real-time event; the models on which the entire spreadsheet generation and the Wall Street relied upon.

The person explained the fall-out. The current situation is worse than the 1930s recession. During the 1930s, the countries tried to reduce ‘balance of payments’ deficit by devaluing their currency (this caused increased competitiveness through cheaper exports). This was fine from a country’s perspective as a short-time panacea; however, it eventually resulted in decrease in demand, decrease in national incomes and high unemployment. This also resulted in lesser foreign investment and reduced international flow of capital.

During the lasting part of the World War II, in order to build and regulate an international monetary order, an obligation was reached among ‘Allied’ nations to maintain the exchange rate of their currency within a fixed value—plus or minus one percent—in terms of gold and the ability of the International Monetary Fund (IMF – formed at that time) to bridge temporary imbalances of payments. In the face of increasing financial strain, the system collapsed in 1971, after the US unilaterally terminated convertibility of the dollars to gold. This action caused considerable financial stress in the world economy and created the unique situation whereby the US dollar became the ‘reserve currency’ for the states which had signed the agreement. (Source – Wikipedia)

What Lies Ahead. With its ‘War on Terrorism’ and ‘Stimulus Packages’, the US will run fiscal deficit for years to come. The Corporate failures mean that the trust on American Philosophy of Business is fast depleting and US Inc may struggle for investments. Where is this money then going to come from? Will China be able to buy up the treasury bonds? Perhaps No, the excesses have been far too much and failures span globally. The people will increasingly realize that US Dollar is a far weaker currency. What more, they will realize that even the EUR or the Yuan is no stronger (due to their own economic situation and corporate performance). The failure of currency markets is imminent, more because of lack of trust rather than lack of value. Gold will again be accepted as a universal mode of exchange. India, because of its infatuation to Gold will be the first country to come out of this very dangerous situation.

So, when is this going to happen? The person said 3-4 years. I have been pessimist of the world economy since June last year (visit my previous blogs), but this takes the evaluation to an entirely new level of pessimism. We met for half an hour or so but the impact was everlasting. I have promised to meet him when the world moves to Gold Standard. I hope I never meet him.