A few days ago the web site energyandgold.com published an interesting interview with Bob Moriarty. The interview is titled “Gold Bottom in, New Bull Market Will Make 2008-2011 Look Tame“, because that’s Bob’s outlook. Bob says a few nice words about me in the interview, but you shouldn’t hold that against him. He’s an astute observer of the markets.

I think Bob’s outlook is plausible, but I’m not expecting anywhere near as much upside in gold-related investments this year as he is. The rebounds from the 2008 bottoms in gold and gold-mining stocks were very quick, but that’s primarily because 2008 was a crash within a continuing cyclical bull market. It wasn’t a cyclical bear market.

The speed with which gold and the mining stocks recover from their 2011-2014 drubbings will be determined by both fundamentals and psychology. Even if the fundamentals become unequivocally gold-bullish in the near future (they are currently either mixed or slightly bullish), history tells me that it could still be at least 12 months before a strong upward trend gets underway. For example, gold’s fundamentals were as bullish as they ever get in early-2001, but the bull market didn’t really get going until 2002.

However, it’s certainly possible that the sentiment shift will happen faster this time around, because the current situation is so far into unprecedented territory that the historical precedents can’t even be seen from here. The mal-investment fostered by central banks over the past several years is simply mindboggling.

For example, the fact that trillions of dollars of government bonds now trade at negative yields reflects mal-investment on a gigantic scale. It means that a huge quantity of wealth has been diverted towards bond speculation and government.

For another example, US corporations have spent hundreds of billions of dollars buying back their own shares instead of investing in business growth. This is a consequence of the perverted incentives created by the Fed.

So, I’m not betting on a rapid change of fortune for gold-related investments, but I can’t rule it out.

Over the most recent Christmas and New Year holiday period, one of the places I visited (with wife and 15-year-old son) was Siem Reap in Cambodia. The town of Siem Reap is best known for, and is a popular tourist destination largely because of, its close proximity to the ruins of Angkor, the capital of Cambodia during the Khmer Empire (9th to 15th Century). Angkor contains the — in some cases largely intact or restored — remnants of some huge temples, including Angkor Wat. However, if (like me) you quickly get bored with temple viewing, Siem Reap is still worth visiting. The town is so vibrant and friendly, with so many interesting eating/drinking places, shops and markets, that I actually wouldn’t mind living there. But the purpose of this post isn’t to discuss the things to see and do in Siem Reap, it’s to discuss some economics-related observations I made while visiting that part of the world.

On arriving at the Siem Reap airport and spending about one hour making our way through the chaotic immigration section I was finally at the document-checking counter, where I had all five digits on both hands scanned for prints. After completing the tedious finger-scanning process I offered to provide a urine sample, but apparently it wasn’t necessary. I thought about giving it to them anyway, but then thought better of it.

What a totally counterproductive exercise in a place that is heavily reliant on tourism! Fortunately, it turned out that the airport was the only bad experience we had in Siem Reap. Not coincidentally, the airport is one of the few parts of the town that is totally controlled by the government. The government, by the way, claims to be democratically elected, but in reality Cambodia is a one-party state headed by a former member of the Khmer Rouge.

The main reason to bring up the airport experience isn’t to complain about the ridiculous security measures and the general inefficiency of the place, it’s because this is where I made the novice mistake of exchanging some US dollars for the local currency, known as the Riel. I didn’t convert much money, thinking that the airport exchange rate would be unattractive, but I shouldn’t have converted any. The reason is that everyone in Siem Reap prefers to deal in US dollars. To put it more accurately, they prefer US dollars to the Riel when receiving payment, although they are happy to give you change in Riel. So, in Siem Reap and perhaps all of Cambodia there are two monies: the money generally perceived to be good (the US$) and the money generally perceived to be not so good (the Riel). This leads me to Gresham’s Law. Cambodia is a good example of why the popular understanding of Gresham’s Law, although it might seem reasonable at first or even second glance, often doesn’t apply in practice.

The popular adaptation of Gresham’s Law is: bad money drives out good. This concept seems to make sense, because people will naturally prefer to hoard the good money and part with the bad money when buying things. However, it generally doesn’t work that way in practice because people will naturally prefer to receive the good money when selling things, so for a trade to take place it will often be necessary for the buyer to offer the good money.

That’s the popular understanding of Gresham’s Law, but the actual principle is: “When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.” That is, Gresham’s Law really only applies in the specific case where there are two equally acceptable types of money and the government fixes the exchange rate between the two. The classic example — and the most relevant example for hundreds of years prior to the last century — is where gold and silver are the most common media of exchange in an economy and the government fixes the gold/silver ratio too high or too low. Actually, even if the ratio is initially set at roughly the right level, changes in the supply of and the demand for the two metals over time will eventually result in one becoming over-valued relative to the other at the official exchange rate. This will lead to the relatively expensive (that is, over-valued) commodity being used progressively more in trade and the relatively cheap (that is, under-valued) commodity being progressively removed from circulation.

In Siem Reap the two types of money aren’t equally acceptable, and although there is an official exchange rate it seemed that people were generally able to trade at whatever rate they deemed appropriate. Consequently, the “bad money” is not driving out the “good money”. On the contrary, the “good money” is thriving as a medium of exchange.

My final Cambodia note is about corruption. Most people believe that all corruption is bad, but in terms of effect on the economy there is both good and bad corruption.

Good corruption is when a government regulation, that for no sensible reason makes it much more difficult for businesses to provide the service that their customers want, can be cheaply ‘got around’ by slipping some money into the pocket of a government rep. In other words, good corruption greases the wheels of commerce. It shouldn’t be required, but in the real world the government puts many unnecessary obstacles in the way of voluntary exchange. An example of good corruption is covered in Jeffrey Tucker’s article about former Washington D.C. mayor Marion Barry.

Bad corruption is when representatives of the government greatly increase the cost of doing business for the purpose of enriching themselves. It is Mafia-style extortion that puts additional obstacles in the way of voluntary exchange.

In Cambodia I saw examples of bad corruption that I suspect are just the tip of the iceberg. In particular, although the town of Siem Reap is a little chaotic (in a good way), it seems that a government licence is required for almost everything. Even setting up a stall selling fried grasshoppers by the side of the road well outside the main town requires a licence. This is not necessarily a big deal by itself, but I found out about cases where the requirement to get a licence made the cost of going into business prohibitive due to the amount of money that has to be paid ‘under the table’ in addition to the official licence fee. For example, I was told that to become a travel agent you must get a licence and to get the licence you must first pass an exam, but that regardless of how well you do in the exam you will not be given a passing grade unless you pay a relatively large bribe to the government-appointed examiner. This is bad corruption. Good corruption would entail slipping a small sum of money to someone to avoid the silly requirement of having to sit the exam.

In conclusion, Siem Reap is a part of the world where good and bad money openly compete, which is the way it should be. It is a great place to visit and perhaps even to live for a while, but I get the impression that it wouldn’t be a great place to set up a business.

(This post is a modified excerpt from a recent TSI commentary)

The year-over-year pace at which US commercial banks create new credit has accelerated — from a low of 1.2% at the beginning of last year to a recent high of around 8.5%. The relevant chart is displayed below. This is why the US monetary backdrop remained ‘easy’ over the past 12 months despite the gradual winding-down to zero of the Fed’s money-pumping. It is probably also why the US stock market was able to rise last year in the face of some serious headwinds.

Modern-day banking has nothing to do with capitalism. It is, instead, a type of fascism or, to use a less emotive word, corporatism. In essence, this means that it is an unholy alliance between government and private enterprise, which involves the government — directly or via its agents, such as the Federal Reserve in the US — having extensive control over the private enterprise and the private enterprise being given special privileges.

In the US and most other developed countries, the bank-government relationship generally encompasses the following repeating sequence:

1. The government either forces or provides financial incentives to the private banks to expand credit in areas where the government wants more credit to flow. At the same time, the central bank makes sure that there is plenty of scope for banks to profit by borrowing short to lend long.

2. The politically-directed or central-bank-stimulated lending causes booms in some economic sectors. While the boom continues, politicians publicly give themselves pats on the back, central bankers bathe in the glory stemming from general confidence in the financial system, and private bankers pay themselves huge bonuses.

3. The boom inevitably turns to bust, leading to massive loan losses and asset write-offs at most banks. It becomes clear that many banks are bankrupt.

4. The government and its agents provide whatever financial support is needed and implement whatever regulatory changes are needed to ensure that the private banks stay afloat. This is done at the expense of the rest of the economy but is invariably sold to the public as being either helpful to the rest of the economy or a necessary evil to prevent a more painful outcome for the overall economy.

5. The private banks, following their near-death experience, ‘pull in their horns’ and focus on repairing their balance sheets. A result is that commercial bank credit creation grinds to a halt or goes into reverse.

6. The cessation of commercial bank credit expansion is viewed by the government and its agents as a drag on the economy and, therefore, as something that must be fought.

7. Return to Step 1.

There are signs that the US is currently transitioning from Step 2 to Step 3, with the shale-oil industry being the leading edge of the next deluge of commercial bank write-offs. However, it isn’t a foregone conclusion. I know that Step 3 is coming, but the exact timing is unknowable. It’s possible, for example, that the acceleration of bank credit creation in other parts of the economy could mask the effects of the collapsing shale-oil boom.

The following chart of euro-zone True Money Supply (TMS) was part of a discussion on monetary inflation in a TSI commentary published last Sunday.

The ECB introduced a new QE program about two weeks ago. This program is scheduled to get underway in March and will add to the euro-zone money supply, but my TMS chart indicates that the euro-zone’s monetary inflation rate has already accelerated. Specifically, the chart shows that the year-over-year (YOY) rate of growth in euro TMS began to trend upward during the second quarter of last year and ended the year above 9%, which is the highest it has been since the first half of 2010. Note that there was a money-supply surge late last year that pushed the YOY growth rate up from 6.4% in October-2014 to 7.3% in November-2014 to 9.3% in December-2014. In other words, the ECB has introduced a new money-pumping program at a time when the money-supply growth rate is already high and rising.

By the way, this is not short- or intermediate-term bearish for the euro. On the contrary, it will be a bullish influence on the euro/US$ exchange rate if it causes European equities to build on their recent relative strength.

The next chart shows the ISM Manufacturing New Orders Index.

The New Orders Index is a US recession indicator. Its message at this time is that a recession is not imminent, although the downturn of the past two months opens up the possibility that a recession signal will be generated within the next couple of months. I currently don’t expect it, but it could happen.

As a recession indicator the historical record of the New Orders Index is good, but not perfect. Sometimes it signals a recession that never comes. However, there is a leading indicator of US recession with a perfect track record, and I’m not talking about the yield curve. This indicator’s current position will be discussed in the next TSI commentary.