In gold we trust?

The huge increase in the supply of money has made its way onto equity markets and resulted in rises in the prices of risk assets (shares) especially in the US. But the effects on economic growth have been much more modest, and the US has struggled to generate enough growth in jobs to decrease its unemployment rate.

The jury is still out on whether the QE strategy will work or not. While in the short term it has increased the price of the assets held by the financial elite, Ron Hera is probably right that in the long term QE will undermine value. Relative to gold, US equities have been in long-term decline since 2000, and this trend is likely to continue for some years before the next turn-around.

It is drawing a long bow to suppose that returning to the gold standard, however, would have prevented the GFC. The early examples of bubbles, such as the South Sea Bubble and the Mississippi Bubble, show us that capitalism is characterised by periodic booms and busts regardless of the type of currency that prevails. Markets can go haywire without the intervention of governments, although governments can contribute. There were severe economic crises in every decade of the 19^th century and up until the Great Depression, right throughout the period when most advanced countries were on the gold standard.

The GFC originated in just such a wild fluctuation in the markets. Of course the prolonged ultra-low interest rates of the Fed contributed to this, but the invention of opaque financial instruments and sheer greed played the largest part. In many countries, unprecedented government deficits were more of an effect of the GFC, as the vast liabilities built up in the private sector were transferred from banks to governments, than a primary cause.

Governments are making things worse, however, by following pro-cyclical instead of contra-cyclical policies. Instead of storing up surpluses in the good times that can then be spent in the bad times, evening out the business cycle, they have sent like drunken sailors in the good times, and then been forced to cut spending massively in the bad times, thus accentuating the effects of the crisis on 'we the people'.

The excesses of economic cycles have their origin in the famous irrational exuberance of investors. Towards the end of the upward phase of the cycle, positive feedback loops form in which investors pay higher and higher prices for assets, prices which are not justified by the real return on investment that the assets can produce. Ultimately stock markets regress towards the mean, and investors who have paid too much for assets that deflate are ruined.

Gold can offer a safe haven in difficult times like this, but is surely no panacea for regulating economies.