Gold is the ultimate Credit Default Swap. It’s meltdown insurance taken out against Federal Reserve Inc. and the global financial system at large. And the best part is, with this CDS you never have to worry about your counterparty.
That simple observation is a worthy retort to all those who yammer on about how “gold has no intrinsic value”… how gold is worthless because “it offers no yield, no return on investment” and so on.
When was the last time you heard someone complaining about the fire insurance policy on their house — the fact that it “offered no yield” etcetera?
When it comes to insurance, yield isn’t the point…
There is a speculative component too, of course. You can make a ton of money buying fire insurance on houses you don’t own. John Paulson taught us that, via his multi-billion-dollar CDS score when the housing bubble turned to bust.
The CDS analogy also applies in that you don’t need armageddon to turn a profit. A company (or a country for that matter) doesn’t need to implode for long CDS to pay off.
All we need to see is a rise in the perceived risk of default — an increase in the statistical probability, however small, that the worst-case scenario could occur.
And this of course explains why the financial establishment hates gold. Ben Bernanke is the CEO of Federal Reserve Inc., and gold is a CDS bet that the organization is flailing and management has lost control.
Let’s keep exploring this parallel. Apart from the recent cycle, when was the last big heyday for gold? The mid to late 1970s — no coincidence the Fed had lost control then too.
(By the way, did you know there was a massive housing bubble in the 1970s, on a scale to rival the latest one?)
Those who pooh-pooh gold do so on the basis of knee-jerk historical recency bias. They point to the extended doldrums of the post-1980 period as evidence of how worthless the yellow metal is.
Reaching into their memory banks and bringing forth the good times of the Reagan-Bush-Clinton years, they mistake a roughly 20-year historical time window for a permanent state of affairs.
Yet once again, the CDS analogy — gold as a bet against Federal Reserve Inc. — sheds light on this mistake.
Not to put too fine a point on it, Fed Chairman Paul Volcker was “the man.” He helped the Fed get its shit together in the late 70s / early 80s. His ability and willingness to do that laid the groundwork for the long period of increasingly leveraged prosperity that followed.
So it’s no wonder that gold went into dormancy after “Tall Paul” broke the back of inflation. Through the actions of an extraordinary leader, the financial system cleansed itself of excess and facilitated a path to healing — exactly the type of environment in which a CDS “meltdown” bet would peak out and decline.
But that was then and this is now. Today we’re on the far side of the leverage and debt supercycle, with unaddressed problems mounting and no competent leadership in sight.
Question: You see any “cleansing of excess” going on in 2010? I don’t. I see a bunch of theory-drunk gamblers (disguised as academics) hooked on double-down martingale strategy.
“If this desperation bet doesn’t work, we’ll just up the size of the next one…”
As a side note, it’s instructive to recall that Volcker was exactly what a Fed Chairman (and perhaps a CEO) should be. Gruff, hard-nosed, determined. A loner type, not a flesh-pressing people-pleaser. Someone who could stoically sit back and take it when outraged homebuilders, crushed by interest rate hikes, started sending 2×4 planks to Volcker’s office with hate notes attached. Someone with the testicular fortitude to do what needed to be done in the face of deafening public outcry.
When “the Maestro” dared to utter the words “irrational exuberance” in the mid-1990s, the political fallout from a swooning stock market scared him so badly he might as well have had his spine surgically removed the very next day. Mr. “I just want to be loved” never again challenged the bullish orthodoxy after that. (Or at least, not until he retired and started craving missed attention…)
And now we have Ben Bernanke, a cowed academic after Greenspan’s own heart. We recently saw the full extent to which “the Ben Bernank” would go to please all manner of masters, and gold surged on the reveal.
The Fed’s solution — MOAR STIMULUS! MOAR PRINT! MOAR! — would be hilarious were it not so tragic. (Come to think of it, it’s darkly hilarious anyway.)
Thus gold, the ultimate CDS, remains a powerful insurance bet that Federal Reserve Inc., under Keystone Cops management, has screwed things up badly and is in danger of making things worse.
And of course, if you like gold, it’s hard not to like gold stocks…