A View from the Trenches, July 25th, 2011: "On gold and a few dogmas"
Please, click here to read this article in pdf format: july-25-2011
Two weeks ago, we wrote that we had bought gold during its sell-off on June 30th /July 1st . We did so reluctantly. and sold it at the close of Friday 15th, consciously against that basic trading rule that says that one has to let profits ride. In perspective, during last week, our proceeds now invested in Canadian dollars made more sense than the oscillation of gold between $1585-$1,605/oz. As we write, we do so on the contrarian side, telling ourselves that it is always better to be out wishing to be in, than to be in, wishing to be out.
We are contrarian because it is hard for us to see gold making higher highs…and yet it does. What is the reason for our position? If prior to August 2nd we have a deal regarding the debt ceiling in the US, gold in our opinion would have to correct, given the reduction in jump to default risk. If we do not have a deal and we face a downgrade or default on US sovereign debt, we think that the world will face a serious run for US dollar liquidity. This, as counterintuitive as it sounds, would appreciate the US dollar, for as long as it takes the Fed to intervene, launching a forced QE3 (debt monetization), whereby downgraded/defaulted debt is purchased. Nobody can honestly quantify this scenario, but from the moment it is triggered to the moment the Fed steps in, we would see assets, among which gold stands as one, selling off. Therefore, we remain on the sidelines, nervous and fighting our greed.
On another note, today we want to write about an issue that is in our opinion the main root of the problems the world faces today: Dogma. We will take here Wikipedia’s heretic definition of “Dogma”:“…Dogma is the established belief or doctrine held by a religion, or by extension by some other group or organization. It is authoritative and not to be disputed, doubted, or diverged from, by the practitioner or believers…”
We think that the world is in trouble today because leaders believe in the following dogmas:
-The existence of an “output gap”
This dogma is nothing else but the complete dismissal of the price system as the most effective tool man has to allocate resources. An output gap is the difference between what is called potential output and real output. What do mainstream economists think a potential output is? Do they think that resource allocation is whimsical? Have they ever stopped to think why is it that entrepreneurs/firms decide to produce less? Obviously not. The answer is simple: To remain profitable. Central bankers lowering interest rates to address this gap is no different than Robert Mugabe’s decision to confiscate farms from farmers who whimsically choose not to increase their output. It leads nowhere and only further complicates things. There is no gap because there is no “potential” output. This is a mechanistic view that if taken to the extreme, should lead us to conclude we should be working all the hours that we do not use to sleep or eat.
-Inflation can be targeted
This dogma is based on another one: The belief that the expansion of money and credit is neutral, which means that it has no effects on relative prices or the structure of production within an economy. If this was correct, it would make sense to keep creating money and credit until the output gap is “closed”. But such creation involves a process where relative prices are seriously changed, affecting production and the relative allocation of resources.
-Well capitalized financial institutions can resist a run for liquidity
This dogma is currently very much in fashion, with Basel I, II and III and why not IV? It is based on the denial that fractional reserve constitutes a fraud. If it is not, we should not believe that financial institutions will face a run. If it is not, all we have to care about is that the expected losses resulting from the investment decisions of these institutions are consistent with their capital. Of course, these investment losses are considered to be random, not the generalized result of a misallocation process, triggered by the expansion of credit and money.
And the last one…”Gold is not money”, as sustained by Ben Bernanke, when asked by Congressman Ron Paul. We leave it to the reader. Here is the Youtube link to it: http://youtu.be/2Dj9v9s9buk
There are more dogmatic beliefs, but we think they are all simply extrapolations of the ones described above. One of these extrapolations, for instance, is the belief that under a system with a central bank and fractional reserve, one should pay a premium (i.e. lower return) to diversify his/her portfolio (i.e. lower risk). This belief is the natural outcome of the dogma of the existence of a risk-free asset (US treasuries).
Unlike the times of Aristarchus of Samos or Nicolaus Copernicus, ours has the fortune of already counting with a diversity of economists/journalists/politicians (mostly from the Austrian school), who can champion the scientific challenge of the dogmas above and communicate it through the Internet. We should therefore be optimistic.
Martin Sibileau
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