Studying Parallels From the Past To Discern The
Future
“History does not repeat itself, but it rhymes.”
If this
be true, it would be a good idea to recount the history of The Great Depression
and the subsequent monetary evolution of currencies and markets, to understand
where we stand today, if history where to ‘rhyme’. I will try and explain why
we should be feeling optimistic just after the recent earthquake.
The story
of the Great Depression starts with the creation of the US Fed in 1918, shortly
after World War I. The reflation and money- printing policies of the new Fed
led to an unprecedented creation of infrastructure spending, which set off
parallel booms in the steel, construction and auto industries. At one time,
there were 108 car cos in the US, of which, about 3 survived after the
Depression.
The current parallel is with the similar booms over 1998-2002 in IT
& Communications first, followed by a housing boom, which was a purely
monetary phenomenon, created by an excess supply of money meant to fight the
Dotcom bust. The whole thing took a decade.
In 1929,
this led to a collapse in asset prices, led by a mistaken squeeze in liquidity,
which converted a bad recession into a full blown Banking crisis and a
Depression. This created a currency crisis in 1933, with the Pound Sterling
going off the Gold Standard.
A currency crisis has been avoided this time, with
the various TARP programmes, which (at least in the US) have worked
surprisingly well. If the new European TARP works similarly, it will have been
the best outcome possible, under the circumstances. But the 2008 crisis still
created a currency crisis in Europe, because of their internal Banking crisis
caused by a crisis of confidence in Sovereign debt cross-holdings. But it took
the same 3-4 years, for an asset price collapse in one part of the world to
expose a currency/ monetary crisis in another part of the world.
After
Britain took the Pound off the Gold Standard, the world economy had no reserve
currency for 11 years, till 1944. In between came the World War, which forced
some countries to print currency, run up huge deficits and lose their Gold
reserves. A parallel development was the loss of some ships carrying Gold from
Europe to the US. This led to the emergence of the US Fort Knox as the
“custodian of the world’s Gold”, creating the ground for its subsequent
emergence as a Reserve Currency. At Bretton Woods in 1944, this was given a
formal shape under the Bretton Woods Agreement.
If we assume that we are now in 1933 equivalent, we
have to look out for this evolution, and this is what should set our
long-term strategy. The new Reserve Currency WILL NOT be the USD; it could
be any one of:
· A strong
(but post-division) Euro made up of Germany, the other AAA countries (Finland,
Netherlands, Austria, Denmark, France, etc). This currency may not be large
enough to replace to USD.
· Chinese
Yuan, but this is unlikely, given the current maturity of the Chinese financial
system. They will have to convince the world that they will not monetise their
coming Banking crisis.
· A
currency evolved by a new Bretton Woods, which considers a composite currency
that takes its value from Gold, Silver, USD and Euro, perhaps. This will be a
possible return to some kind of Gold Standard, reducing the panic in currency
markets.
Right now, we have seen that in a panic, people
rush into USD. Even Gold is not the safe haven that it used to be; Silver has
proved positively dangerous for many people. But this may not continue. In
fact, I would want to bet on the fact that Silver will go into a long-term
(relative) decline to both Gold and currencies. I will argue this today with
technical data. If we get this right, it will create very long-term profits;
how big depends on how much we believe in the above “history rhyming”.
So one should be long-term bearish the USD,
long-term bullish the (post-division) Euro, long-term bearish Silver. I am
unable to give an opinion on Gold, which has already fallen 20% from its Dollar
peak. Silver has dropped 40%. But while the USD has not yet started its
(long-term) decline, Silver is already half-way through its long-term decline.
The CNY will appreciate in relative terms, as will the Re and other major EM
currencies.
Between
1944 and 1971, there were NO Banking Crises, despite a long-term boom starting
in 1955. The big change happened after the Oil Crisis, when Nixon took the USD
off its Gold peg. Immediately, this started off the run-up to the Latin
American debt crisis, followed by the Plaza Accord in 1985. The resultant
increase in the (relative) purchasing power of the Yen led to the Japanese
asset bubble of 1989 (when the palace of the Japanese Emperor was worth more
than the whole of Manhattan). The subsequent bubble collapse, combined with
their demographic decline, has created the only Deflationary Crisis we have
seen this last century.
It is now pretty clear that the US does not have
the demographic decline that Japan has, nor did it leave its reflationary
policies too late. The deleveraging of the US household should be completed in
about 4-7 years, while the US corporate sector has already reached stability
(as seen by the very shallow decline in the US Dow Jones Index, despite such a
cataclysmic decline across the world). The only problem left over will be Govt
indebtedness, which might follow the same pattern as in Japan: i.e. everyone
will keep talking about a coming crisis of confidence, but since most
borrowings will be held by domestic savers, this crisis of confidence will be
pushed back indefinitely.
CONCLUSION: we should bet on the long-term
(relative) decline of the USD, long-term appreciation of some other (Gold)
standard currency, shallow and long-term decline of Silver, with a lot of
uncertainty about whether Gold will also follow Silver.
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