James Saft

In investing, extreme behavior is becoming more mainstream every day.

How else can we interpret the extraordinary moves by the University of Texas’ endowment fund to not only buy nearly $1 billion of gold, equal to about 5 percent of its assets, but to insist on taking physical delivery of the precious metal.

Things really have come to an interesting juncture when the second-largest academic endowment in the U.S., managed and advised by sober, rational people, decides that what they need is insurance against getting, in essence, robbed, via inflation, by fiscal and monetary policy.

Little wonder that gold futures went above $1,500 per ounce for the first time on Wednesday, driven by a laundry list of concerns starting with a falling dollar and not ending with the growing chance of “debt restructuring” (well, default, if you insist) by Greece.

“The role gold plays in our portfolio is as a hedge against currencies. The concern is that we have excess monetary and fiscal stimulus,” Bruce Zimmerman, chief executive officer of The University of Texas Investment Management Company told CNBC television.

While Zimmerman said it was easier and more economical for the fund to physically accept the gold, which it is paying to store in a vault presumably deep below the sidewalks of New York, rather than the more usual route of buying a derivative contract, the move also must reflect concern about the risk of those contracts not being honored. To that extent the investment is not only protection against inflation and currency risk, but against market failure as well.

Zimmerman has described gold as an “anti-currency,” as,  being in limited supply, its value can’t be degraded by central bank-engineered inflation and devaluation. You can’t turn on the printing presses and make more gold, a slender but apparently important virtue.

That’s a legitimate concern, though the kind of scenario that would only have been raised on the most feverish message boards until a couple of years ago. Since the second round of quantitative easing was signaled last August the dollar has fallen about 11 percent against a trade-weighted basket of currencies.

The dollar has fallen particularly hard in recent days, even against the beleaguered euro, after Standard & Poor’s put the U.S. on warning that it has a one-in-three chance of losing its AAA debt rating. Some of the same fears that drove S&P’s move are driving the gold market; the idea that the U.S. will not get its act together to agree budget reform and, in becoming a worse credit, sees the dollar weaken precipitously.

THE ANTI-INVESTMENT
Rather than being an anti-currency, gold is really an anti-investment, not because it can’t pay off, but because it is the one asset that not only protects you against the bad actions of others but actually rewards you for them.

If central bankers and politicians bring on massive inflation, gold goes up. If the U.S. threatens to slouch or leap towards default, gold goes up.

The opposite of buying gold perhaps is to buy equities, because you are betting on creating products, jobs and wealth rather than just protecting yourself. On the other hand, a bar of gold has no executives that can loot the company or accountants that can aid in fraud.  Really the world in which an investment in gold makes you rich is not a very appealing place.

In some ways you can look on capital flowing into gold as a kind of unexpected cost of current monetary policy, just as putting bars on your windows is a cost of living in a dangerous neighborhood. Both divert money away from more productive causes in service to security.

It is really hard to say which is more remarkable; that people are behaving in ways that might have been labeled as paranoid a few years ago or the rise of things that plausibly might make them worried.

The lack of safe alternatives to the dollar is also doubtless driving money to gold. While the euro has rallied against the dollar on expectations of further interest rate rises, its policies towards its ailing member states are in a shambles. There is a real risk that a restructuring by Greece and continued problems in Ireland and Portugal cause contagion to Spain, an economy big enough to call the whole project into question. Electoral gains by a nationalist party in Finland that rejects bailouts only adds to the potential difficulties.

China, though supposedly keen to promote the yuan as an alternative to the dollar, is still partly a closed economy for outside investors. Japan, recovering from disaster and facing huge demographic challenges, is also, though open and big, hardly appetizing.

Gold, then, is a profoundly pessimistic and depressing investment. In current circumstances it also, unfortunately, has a heck of an elevator pitch.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.com)

Call it what you like — war, tragedy or farce — but the disagreement over global currency exchange rates shows no sign of coming to a peaceful negotiated agreement.

Asked last week if loose Federal Reserve monetary policy was to blame for inflation in emerging markets, Ben Bernanke stoutly denied that it was anything to do with him, maintaining in central banker-speak that he’d been tucked up in bed at home at the time.

“I think it’s entirely unfair to attribute excess demand pressures in emerging markets to U.S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries,” the Fed chief told reporters assembled at the National Press Club in Washington.

“It’s really up to emerging markets to find appropriate tools to balance their own growth.”

Now on the face of it, that statement is a nonsense: regardless of emerging markets, like say, China, having tools at their disposal to put out the fire of domestic inflation, it is still possible, even likely, that Fed policy is partly responsible for widespread commodity price pressures.

Bernanke is right that rising living standards in emerging markets play an important role in price pressures and right too to point out that emerging markets have unused tools at their disposal.

“They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something that they’ve been reluctant to do in some cases,” Mr Bernanke said.

Bernanke argued that inflation in the U.S. did not yet appear to be a threat while high rates of unemployment were. Unsaid in this is that China’s policy of artificially keeping the yuan cheap has played a role in high rates of U.S. unemployment.

The U.S. stepped up its rhetoric against Chinese policy in a report from the Treasury Department last week, stopping short of labeling China a currency manipulator but calling the yuan “substantially undervalued” and complaining that “progress thus far is insufficient and that more rapid progress is needed.”

China for its part seems utterly unlikely to do very much to substantially address the issue of a weak yuan, based both on its track record and recent body language.

The truth is that this is a dangerous and destructive way to manage competing global interests, dangerous both in terms of the threats of inflation and hunger and destructive in the ways that Chinese policy has helped to distort the global economy over the past decade, albeit with a massive helping hand from overly loose U.S. policy.

A WIDENING CONFLICT
No one should expect the rest of the world to sit by as the dueling Chinese and American policies spray stray bullets into the crowd.

French Finance Minister Christine Lagarde on Sunday was forthright, blaming a, for her, highly inconvenient strength in the euro on the U.S and the Chinese.

“We must reform the international monetary system so that the euro is not caught in the middle, hit by the expense of trade-offs between two currencies that are deliberately weak,” Ms. Lagarde said in an interview on French television.

And while the word “China” did not pass his lips, U.S. Treasury Secretary Geithner’s meaning was clear on Monday on a visit to Brazil:

“Brazil is seeing a surge in capital inflows. This is happening for two reasons. First, investors around the world see Brazil growing at a faster pace and offering higher rates of return relative to other major economies. But these flows have been magnified by the policies of other emerging economies that are trying to sustain undervalued currencies, with tightly controlled exchange rate regimes.”

That is both true and not true; Chinese policy is terrible for Brazilian industry, threatening to turn the country into a larder for natural resources while suppressing other exports, but a lot of the money which is flooding the country and pressuring its currency upward is part of a huge carry trade that is directly attributable to U.S. monetary policy.

In this way perhaps the real risk of the currency skirmishes is that all countries are so focused on getting their share of global growth that they fail to take individual steps to control inflation, and thus allow it to grow rapidly in a way that proves difficult to control.

It does not have to work out that way; an inflation shock that does not become self-reinforcing will kill asset returns but whittle down debts in a very useful way.

The truth though is many countries are all trying to control the same knife at the same time and that is a tough way to whittle.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.com)

The trans-Atlantic economic contrast is shaping up as pitting British austerity against, not U.S. investment, but a do-little American muddle.

President Obama’s State of the Union Address offered him the opportunity to hold up a beacon of policy that invests for the future while taking credible steps to control future deficits.

Speaking not long after Britain, in the process of making severe cuts in spending, reported a shrinking economy in the fourth quarter of 2010, Obama instead delivered a vague mix of un-costed investments and symbolic cuts in discretionary spending.

This of course is not entirely the U.S. administration’s fault; it must work with an austerity-happy Republican party that controls the House of Representatives and in service to an electorate which appears to have lost faith in the ability of its leaders to invest wisely. That virtually ensures a muddle in which serious cuts will be elusive and investments watery.

In contrast, even a delicate coalition like the one in power in Britain can ram through Parliament a full-bodied program of spending cuts and tax hikes.

Britain on Tuesday recorded a 0.5 percent decrease in gross domestic product in the quarter ended Dec. 31 compared to the three months before, far below not only consensus but even the most pessimistic of forecasts.

While the data is partly explained by the coldest December in more than a century, there appears to be an excellent chance that Britain is in the process of double-dipping back into recession. That would be extremely awkward for the Tory-led coalition which last summer embarked on a plan of austerity that aims to cut spending at national agencies by 25 percent by 2014. It is unlikely that this plan by itself sank the economy in the fourth quarter, but it will certainly help to sink it going forward.

The argument in favor of austerity is pretty straightforward; Britain is small, is deeply in debt, its pound is not a reserve currency and so it must maintain the confidence of global investors in its debt or face a disastrous eventual buyers strike. Britain, this argument goes, has no choice but to take its lumps. As Bank of England Governor Mervyn King pointed out on Tuesday real British wages are likely to have showed no growth in six years to 2011, the worst such period since the 1920s.

RESERVE CURRENCY; BLESSING OR CURSE?
Looked at from this point of view the U.S.’s inability to both invest and cut is even more of a wasted opportunity. While there are important differences between the British and U.S. economies — the U.S. is more diverse and carries less debt –  one crucial one is that the dollar is the premier global reserve currency.

That gives the U.S. a lot of built-in credit in global markets and makes possible policies which Britain simply could not risk, much less get away with. If the U.S. made up its mind to do it, it could make massive investments in infrastructure and other high-yielding projects while at the same time addressing its deficit over the medium term. That has the chance, not the certainty, of increasing growth and making the deficit melt proportionally.

The privilege of being a reserve currency also gives the U.S. the illusion that it can dawdle and in-fight indefinitely as it is not being punished in markets for its policies. Market confidence for the U.S. though may prove to be something that doesn’t erode, as it did for Greece, but shatters after long and hard use.

With the U.S. politically unable to get to grips with its economic future, the Federal Reserve is left as the one institution with the power and the means to act, and act it has, launching a successful attempt to drive up asset prices and a less successful one to drive down the dollar.

That of course is the problem, and the same one the U.S. had in the last decade; loose money leads not to long-term investment in great infrastructure or human capital but to speculative bubbles and financial chicanery. The contrast is not between a free market which will respond to price signals and inefficient central planning, but between inefficient central planning and a casino in which the house lends the players money to bet.

In the end, in both the U.S. and Britain, austerity or not, investment or not, the next several years will involve at best scant gains in real living standards as the bills for the financial crisis and the rebalancing of the global economy are paid.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: jamessaft@jamessaft.com)

If the euro is going to survive without a Depression, German consumers are going to have to behave in ways that are, well, distinctly un-German.

While attention is focused on the suffering that the euro zone debt debacle is inflicting on the weak and the political anger the costs of bailouts are engendering among the strong, it is important to understand that the belt-tightening won’t just be a Gaelic and Mediterranean phenomenon.

German consumers will (rightly) regard events as likely to increase their taxes while doing precious little for their incomes and job prospects. If they react to this like Americans and spend like there is no tomorrow, well then, perhaps the euro zone can handle the local recessions in the Austerity Provinces. If, on the other hand, Germans behave anything like the way they have in the past, they will save more and only increase spending marginally, if at all.

“Over the four quarters to 2011 Q4 it is hard to see (German consumer spending) growth exceeding 1 percent, and easy to see it falling short, especially if budgetary rigour, rising food and energy prices, and the need for further Club Med subsidy provoke the normal reaction from German consumers,” Charles Dumas of Lombard Street Research in London wrote in a note to clients.

Against the wider backdrop this is not encouraging; U.S. demand will be weak, China is trying to stomp on inflation and the euro zone periphery will very likely be contracting. That really does leave German consumers as the engine of euro zone growth — a role that is, for them, unusual.

To put this in context, since the fourth quarter of 2001 German consumer spending is only up a bit more than 2 percent in real terms, a truly measly expansion. During the same period the household savings rate has risen from about 9 percent to just above 11 percent.

During this time, you will recall, the world experienced a go-go real estate bubble with seemingly free money, much of it German in origin, available to plough into collateralized debt obligations and the like.

If German consumers reacted soberly to the good times, imagine what they will do in coming years when confronted with the risks and costs of either staying in or exiting the euro.

Part of the reasons for German consumer reserve was a policy that constrained wage growth savagely, but again, to look for strong wage growth to emerge at this stage is wishful.

NICE RECOVERY?
Much has been made of the fact that Germany’s economy grew strongly last year, rising 3.6 percent, the strongest showing since its east and west were reunified. While this is a fine start, Germany did shrink by 4.7 percent the year before and its economy is still 2 percent smaller in real terms than it was at its peak.

While European, including German, officialdom is absolutely opposed to a euro exit, repeatedly characterising it as disastrous and unthinkable, it might not actually be that bad for German consumers, at least after a while.

Dumas of Lombard Street argues that the hit to competitiveness from a newly risen new-deutschemark would be offset by gains in consumers real income and confidence.

“A higher exchange rate would probably cause a healthy redistribution of income from business to labour, ie, consumers — the lack of which is closely connected to undervaluation and excess savings and net export surpluses in Japan and China, as well as Germany.

“Since Germany is unlikely to follow China’s route of real exchange rate appreciation by means of wage inflation, giving some possibility of a shift to consumption from exports, a break-up of EMU may actually be the only hope for achieving an increase of welfare for ordinary Germans.”

Given the current alignment of opinions that is not the most likely outcome, to put it mildly.

What does seem likely is some combination of the following: a recession among the weak in the euro zone exacerbates and is exacerbated by a failure of German demand in the face of uncertainty and limited global demand.

That will raise the rhetoric of euro zone discord and will weaken the euro, causing a problem for the dollarized world, including China. China’s willingness to spend billions to prop up demand for euro zone debt is in no small part because of this.

Europe will remain a strongly deflationary force in the global economy and the biggest risk in the near term as a force to upset the giddiness that is now dominant in global markets.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.com)