Friday, July 23, 2010

"Something has to give."

"Buttonwood" over at the Economist has penned a piece wondering about the disjoint between the rise in gold and low interest rates. When the U.S. dollar is looked at in terms of gold, a large de facto devaluation (80%) has taken place. Despite that, interest rates for Treasury securities are at near-record lows.
One reason why countries tried so hard to maintain the gold standard and the Bretton Woods system was to reassure creditors that they would be repaid in sound money. Since 1971 most countries have had the right to repay creditors in money they could print at will. The likes of America and Britain are now perceived as “lucky” because they, unlike Greece, can devalue their currencies and default in real terms.

That prospect did alarm creditors in the 1980s when the real yields on government debt shot up. But it does not seem to now. America and Britain are paying only 3-3.5% to borrow for ten years. That may be because deflation seems the more immediate threat. It may be because bond markets are now dominated by other central banks, which are more interested in managing exchange rates than in raising returns. But it is not stable to combine low yields, high deficits and governments that are happy to see their currencies depreciate. Something has to give.
It's been quite the disjoint, which has existed for close to two years now. One explanation for it is another disjoint, between official inflation rates and the ones calculated by John Williams of Shadowstats. The former jibes with the bond market, while the latter gibes with gold's performance. Shadowstats' alternate measure, which is the same methodology used in the 1970s, shows 1970s-era inflation in the U.S. right now.

This point doesn't deflect "Buttonwood"'s final remark, but it does explain why the disconnect has been in place for so long. Something indeed has to give, because both can't be right.


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