Professor Lew Spellman, from the McCombs School of Business at the University of Texas at Austin, has posted on on what he calls gold’s changing role in the global economic landscape.
Amongst other things, he says the epic hunt for “safe collateral” — which has driven down yields on traditional fixed-income investments in the process — is the direct result of there being too many debt liabilities/obligations relative to safe collateral in the system.
In a zero-yielding environment like this he believes gold naturally starts to look attractive — especially if it remains a liquid store of value that’s widely accepted as collateral. After all, there’s now little to differentiate it from zero-yielding Treasury bonds. In fact, gold might even be considered more attractive because it doesn’t feature a bond-type expiry.
As Spellman explains:
Hence, the great corollary of over indebtedness is the relative scarcity of good collateral to support the debt load outstanding. This imbalance of debt to collateral is impacting the ability of banks to make loans to their customers, for central banks to make loans to commercial banks, and for shadow banks to be funded by the overnight Repo market. Hence the growth of gold as a collateral asset to debt heavy markets is inevitably in the cards and is de facto occurring. Gold is stepping up to the plate as “good” collateral in a world of bad collateral.
All of which could be indicating that the market is unwittingly moving towards a collateral-backed global currency (on its own accord). Possibly, even, towards a new gold standard altogether:
What we are witnessing is a sea change in which market forces are driving a de facto return to the gold standard. All that is missing for this to be a de jure gold standard is some regulatory and legal recognition and one has been proposed. The Basel Committee for Bank Supervision, the maker of global capital requirements is studying making gold a bank capital Tier 1 asset.
Which foretells the following for gold:
The world has gravitated from one gold-backed paper currency to another before, and it likely is happening again. It would depend on whether investors in liquid, default-free, inflation-free paper prefer gold-backed Chinese Yuan to Swiss warehouse receipts or deposits from large international banks with large gold positions that operate with lots of leverage. This is a market choice that will determine the gold linked paper store of value, but the point is that all the paper contenders derive value from the gold backing, and thereby expands the demand for the shiny metal. This is the new calculus of gold. This state of affairs is likely to remain until developed world governments no longer reach for the unreachable and pressure their central banks to finance it.
Now, at FT Alphaville we’ve played around with the idea that some type of market mind-meld may be going on, encouraging the re-collateralisation of the system’s liabilities.
You could think of it as a giant game of musical chairs. While the music plays, nobody cares if there is a lack of chairs (assets) in the game. Probability wise, participants feel they will be able to get a chair if and when they need one.
But what happens when the music stops and there are far fewer chairs than anyone expected? (And when the probability of winding up with no chair next time round is much higher than originally expected?) In that scenario participants begin to “eye” potential seats ever more closely. Anyone with a stake in the game might even choose to reserve a seat by paying off fellow participants.
That process of reserving a seat echoes the collateralisation that’s going on today. Collateralisation equals the location and identification of real-world assets against which existing financial claims can be satisfied. If there’s a lack of acceptable assets in the system versus outstanding claims — the stakes in the financial version of musical chairs rise significantly. As does the cost of reserving a seat, a fact which manifests in the real world as negative yields.
This is why ‘the debt-to-safe asset ratio’ may be worth paying attention to?
Warren Buffet and the New Calculus of Gold – Spellman Report
The decline of safe assets – FT Alphaville
Dealing with a global Triffin dilemma – FT Alphaville
Treasuries are the new gold – FT Alphaville
Make your own (collateralised) gold standard – FT Alphaville