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Debt Jubilees Good for Gold

13 December 2019

Precious Metals Commentary

A more volatile week for precious metal prices saw gold trade as high as $1,486 before being smacked down overnight. Prices have stabilised at USD$1,470 for now and silver again is much the same as last week: $16.95 per ounce.

Gold looked like it could start a more sustained rally, with the price rallying 1% on the back of a combination of downbeat US data and dovish comments from the ECB. But all of those gains were given back when Donald Trump tweeted the comment below to upset the party.
 
Donald Trump Tweet
CFDs on Gold Chart
In AUD terms, we are much lower than last week, largely thanks to the spike in the AUD to 0.69c. Gold is trading at $2,129 at time of writing with silver lower too at $24.60. Both metals very close to the lows of the past 3 months.

Palladium hit fresh record highs and broke through the $1,900 level as prices rose for the 13th session in a row on supply concerns.

The power crisis in South Africa, which is the world's top platinum and second-biggest palladium producer, was cited as the reason for the latest move in prices.

"It is not particularly surprising that palladium is doing well. We think it will hit $2,000 at the latter part of next year when gold does better as well," TD Securities head of global strategy Bart Melek said back in November. "We formally have $2,000 average in Q4 2020, but given normal volatilities, it could be $2,100-2,150. We wouldn't be shocked if that happened."
 

Golden Jubilee

Modern Monetary Theory (or the Magic Money Tree) continues to gain adherents, with Democratic presidential candidates such as Elizabeth Warren and Bernie Sanders trying to one up each other with plans to cancel student loans or medical debt.

Proponents of MMT would achieve this by the government buying up the debt with newly printed magic money. That would be inflationary, but this is not considered a problem by the theorists as economists consider we aren’t getting enough inflation now.

The other way it could be funded is by government selling its own debt and using that money to buy the debt they want to cancel.

Either method ends up making everyone pay, either by a general increase in inflation or higher taxes required to service the government’s increased interest payments.

The other issue is one of fairness. Why should existing debt holders benefit but future borrowers have to pay? And won’t those future lenders and borrowers not worry about being prudent as they would expect a future government to cancel their debts when they become too big?

So proposals to forgive debt invariably require the thing being forgiven to be perpetually state funded, which just adds to the burden for the rest of the population.

Such debt cancellations or forgiveness are just a modern form of debt jubilee, which was first introduced by the Sumerians and thus has a history just as long as gold as money.

Australian economist Steve Keen has been proposing the idea of jubilee for many years and to deal with the equity issue his plan is that everyone gets the same amount of money deposited into their bank accounts with only one stipulation – if you have debt, the free money is first applied against paying that back.

The result is that borrowers get their loans reduced but savers would end up with additional free money.

Steve says that the Sumerians instituted debt jubilees because they identified that debt tended to exponentially increase over time with the result that the majority of the population ended up becoming slaves when they couldn’t repay the debt (sounds familiar…).

While modern bankruptcy laws are a better solution than slavery, we have noted previously how much household debt has been increasing as people struggle to maintain their standard of living, or just living, resulting in being a slave to debt.

As life becomes increasingly hard (and they are doing it tough in WA if 1 in 60 customers are getting their power cut off, see chart below), we have to consider the possibility that the idea of everyone getting a few hundred thousand - and it would have to be that much to make a difference - for free could gain traction and actually one day become reality.

Number of electricity disconnections for non-payment by financial year chart
What would be result of such a policy? Certainly inflation would be the outcome and gold would likely be the go-to asset to protect against that.

But later there would be an unintended consequence that borrowers may not be so keen on after the initial boost from the debt reduction.

The key feature of historical debt jubilees was that they were regular, usually on the coronation of a new king. Even if our modern jubilee was promoted as being a one-off, once that door is opened people would expect or pressure for it to happen again.

Now put yourself in the shoes of a saver/lender. If the jubilee was a brutal one like in ancient history where the debt was just written off, you wouldn’t be keen on extending 30-year mortgages. The result would be a severe reduction in the terms lenders would be willing to extend loans for.

Consider a loan for $500,000 at 3% for 30 years has a monthly repayment of $2,109. If terms were reduced to 15 years, that some monthly repayment would only service a $304,000 debt. Such a cut of 40% in borrowing power would have a commensurate impact on the price of homes and other assets.

In the case of a Steve Keen MMT-style magic money drop, while a lender would get the balance of their loan repaid, such large semi-regular injections of money and the resulting inflation would result in lenders just increasing the interest rate they charge to cover the expected devaluation of the money when the next jubilee occurs.

Such interest rate increases would have the same impact on borrowing power.

As an asset that is rarely bought with borrowed money, physical gold would benefit from such unintended consequences.

We don’t want to make too much of the risks of a jubilee, which at this time is very much a discussion happening in academic and intellectual circles. However, as Deutsche Bank Research said recently, “we believe it is best to be prepared for the unexpected themes that may arise over the coming decade”, one of which is that the “current fiat system together now look fragile and they could unravel in the 2020s”, in which case they see demand for alternative currencies, such as gold or crypto, soaring.

MMT advocates argue that runaway inflation is not a risk. Professor Bill Mitchell, of the University of Newcastle, says that the theory requires government to pull back on the magic money as inflation rises and the economy reaches its capacity. He also said that the threat of financial markets driving down a country’s currency as money is printed is overrated.

Why is that? Well he says that “if the currency sold off you can just introduce capital controls and that would be the end of that. The legislative system would triumph.”

A good insight into the thinking behind MMT and respect (not) for individual liberty it will have when unintended consequences develop.

Maybe Professor Mitchell should have a chat to some South Africans or Lebanese and see what they think of capital controls. South Africans have been operating under capital controls for many years and are currently limited to sending 1 million rand (~$98,900) out of the country without a declaration and only 10 million rand (~$989,000) with a special application to the South African Revenue Service (subject to the benevolence of a bureaucrat).

Lebanon has seen nationwide protests since October due to discontent with economic mismanagement and corruption. Banks there have effectively imposed capital controls limiting the amount of dollars customers can withdraw or transfer out of the country as ratings agency Fitch cut Lebanon‘s credit rating for a third time in a year on Thursday.
 

Blimp-Sized Black Swans

Goldman Sachs says that the strategic case for owning gold remains strong and they have identified a significant build in non-transparent gold stocks driven by “worries among the global elite like wealth taxes and increasing talk about MMT and central bank effectiveness”.

Implied build in non-transparent gold investment has been larger than the build in gold ETFs chart
They say that it makes sense for individuals trying to minimize the risks of sanctions or wealth taxes to buy “physical gold bars and storing them in a vault, where it is more difficult for governments to reach them”.

Mitsubishi head of business development Jonathan Butler confirms our view that interest in gold to-date has been smart money, saying they “continue to favor bullion, even as equities and other risk assets hit new highs, indicates the long-term haven status that many investors attach to gold”.

Respected financial markets commentator, Harley Bassman, says that gold is a “sleep well at night” asset and is not something you trade – “it is a twenty-year horizon asset diversification to hedge against a blimp-sized black swan landing in your backyard”. We tend to agree.
 

Interview on Crypto Gold

Last week Bron was interviewed by Alex Saunders of crypto newsletter Nugget’s News. You can catch it on Youtube or Soundcloud podcast.

It was a broad ranging discussion covering history of money, precious metals market cycles, what Austrian economist got wrong about Bitcoin in 2009, bubble market dynamics in gold and crypto, maturity transformation and fractional reserve bullion banking, lease rates as an indicator of bullion bank liquidity issues and of course, precious metals manipulation.

Until next time,
 
John Feeney and Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at comms@abcbullion.com.au, or call us during trading hours on 1300 361 261.

Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.