财经观察 1785 --- The next Lowdown

 

** Note: The next Lowdown will be at the end of next week when I return from a business trip. **

 

* "PUBLIC-PRIVATE" - Some of the brighter lights in the media are starting to wonder what kind of restrictions will be placed on *any* private investor or company that participates in the U.S. Treasury's proposed Public-Private Investment Fund (i.e., TALF).

 

* NATIONALIZATION & GOLD - The precious metal has been pushed steadily higher since Inaugural Day (Jan 20th) in the United States. Investors remain fearful of confiscation through nationalization. As such, they are withdrawing capital from the financial system and looking for the safest places to park their wealth.

 

 

 

* "PUBLIC-PRIVATE" - The attached Bloomberg story about the newly mandated restrictions on the incomes of employees of TARP banks contains the following passage:

 

"It’s unclear whether the rules will apply to Public-Private Investment Fund, the Treasury’s effort to remove the toxic assets clogging banks’ balance sheets. The fund would offer government financing to help induce private investors such as hedge funds to purchase illiquid securities."

 

If it is "unclear" to a journalist, then what do you think a potential investor in the "public-private" scheme would be thinking?  Would that potential investor (e.g., hedge fund) have observed how the Congress imposed restrictions on TARP recipients in a unilateral and retroactive manner? Would that potential investor have observed that political leaders in Washington have implemented populist restrictions that undermine the rights of shareholders and, therefore, undermine the value of capital invested in financial institutions?  Is it reasonable to believe that such a potential investor may worry that any "partnership" with the government will result in similar restrictions? Can you imagine the headlines in the future: 'hedge funds profit on government financing' and the "public" uproar that would follow? Would such a populist uproar result in retroactive restrictions on TALF participants?

 

I raise these questions because it is reasonable that the "private" side of the "Public-Private Investment Fund" may be asking similar things. Notice that the U.S. Treasury is the one that titled the proposed organization as the "Public-Private Investment Fund." Perhaps unintended in that title is the clear order of priorities of such an entity. The PUBLIC comes first. The PRIVATE comes second (i.e., will be subordinated). In fact, that has been the order of things whenever the government "invested" in private institutions.

 

In my opinion, the uncertainties that I outlined above will continue to weigh on "risk" assets in the near-term. As I have noted in the past, the government has tried EVERYTHING in reacting to financial and economic problems EXCEPT the protection of investors' rights. Confidence can NOT return unless the government starts protecting as opposed to violating the rights of investors. Trillions of dollars can not buy that confidence.

 

(If I'm sounding like a broken record by now, then all I can say is that this is the over-riding issue of our era that has been the cause of the significant loss of value in markets and the economy. Furthermore, the trend in this area has been *worsening* with no sign of improvement at all.)

 

* NATIONALIZATION & GOLD - Investors remain fearful of confiscation. As such, they are withdrawing capital from the financial system and looking for the safest places to park their wealth. Government bonds have been a favorite destination of investors who seek to park their funds in an unproductive asset until a time when the investment environment improves. However, government bonds are not risk free. They face significant risk of degradation from potentially higher rates of inflation caused by governments' massive deficit spending and debt monetization.

 

This is where gold comes in handy. The price of gold can only be pushed down by credible policies of the government. That is, the only way for the price of gold to trend lower is for the government to implement policies that cause rates of inflation to decline. Such policies would include reductions in spending and reductions in debt monetization (i.e., reductions in the amount of new money that the central bank prints up). In my opinion, it is highly unlikely that the government will turn toward fiscal and monetary prudence in the years ahead. This in turn reduces the risk of holding gold. On the contrary, this fact increases the attractiveness of holding gold as a protection against profligate government spending and inflating.

 

The increase in the price of gold -- which is more accurately described as a devaluation of money -- indicates investors' declining confidence in the policies of Washington. Of course, the U.S. is not alone in the race for the bottom. Gold is hitting new highs against almost all currencies. Another way to say all this is that there is a breakdown in trust in governments.

 

Remember this: the favorite way for governments to confiscate wealth is through the default of its bonds. In modern days with fiat paper currencies and central banks, the government almost always accomplishes this not through technical default, but through debt monetization (i.e., through the process of inflation). Gold is not susceptible to such stealth confiscation.  Of course, there is a precedent of the U.S. Government overtly confiscating gold from citizens. This was done by FDR's executive order in May 1933 (see: ). But such a confiscation is more difficult to pull off than inflation and, hopefully, more controversial among the population.

 

It is during times of political confusion that gold holds its real purchasing power. With those "cheerful" comments, I wish you a good weekend. Again, the next Lowdown likely will be issued next Friday.

 

Kenneth Landon, Feb 20, 2009