March 6, 2017

[This blog post is an excerpt from a recent TSI commentary]

If the future were 100% certain then there would be no reason to have any monetary savings. You could be fully invested all of the time and only raise cash immediately prior to cash being needed. By the same token, if the future were very uncertain then you would probably want to have a lot more cash than usual in reserve. This has critical implications for the gold market.

The answer to the question “What is the root cause of a gold bull market?” is related to the propensity to save. When there is an increase in uncertainty and/or the perceived level of economic/financial-market risk, people naturally want to save more and spend less. This is especially the case after an economy-wide inflation-fueled boom turns to bust, because in this situation debt levels will be high, many investments that were expected to generate large returns will be shown to have been ill-conceived, and it will be clear that much of what was generally believed about the economy was completely wrong.

The public’s first choice in such circumstances would be to hold more money, but central banks and governments typically respond to the factors that prompt people to save more by taking actions that reduce the value of money. Policy-makers do this because they are operating from the Keynesian playbook in which almost everything is backward. In the real world an increase in saving comes at the beginning of the economic growth path and an increase in consumption-spending comes at the end, but in the Keynesian world the economic growth path begins with an increase in consumption-spending. Moreover, in the back-to-front world imagined by Keynesian economists an increase in saving is considered bad because it results in less immediate consumption.

So, stuff happens that makes the public want to save more, but the central-planners then say: “If you save more in terms of money we will punish you!” They don’t actually say “we will punish you”, but they take actions that guarantee a real loss on cash savings. Also, in times of stress the most popular repositories of money (commercial banks) will often look unsafe.

Now, neither the actions taken by the central bank to reduce the appeal of saving in terms of the official money nor the appearance of increasing ‘shakiness’ in the normal repositories of money will do anything to reduce the underlying desire for more monetary savings. In fact, the panicked actions of the central bank can add to the uncertainty, thus leading to an even greater propensity to hold cash in reserve.

That’s where gold comes in. People want to save more money, but they can’t save in terms of the official money unless they are prepared to lock-in a negative real return on their savings and/or accept a greater risk of loss due to bank failure. They therefore opt for the next best thing: gold. Gold is almost as liquid and as transportable as money, but its supply is essentially fixed. Gold also has a very long history as a store of value and as money, so even though it is presently not money it is a good alternative to cash.

Long-term gold bull markets can therefore be viewed as periods when the public has an increasing propensity to save and when the actions of the authorities and/or the weakened financial positions of the commercial banks make it riskier to save in terms of the official money.

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