Gold and the Moral Hazards of Cheap Money

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By Jacob Maslow

Gold bars
Gold bars

Usually with all things being equal, investors would park their money in gold when there is economic uncertainty. It doesn’t take a genius to see that the global financial markets are running on fumes. These are fumes produced by all the cheap liquidity arising out of stimulus schemes. These schemes were launched by central banks in response to the great financial crisis of 2008.

If you look at baseline economic fundamentals and real growth, the world hasn’t really completely awaken from that nightmare. Not surprisingly, Japan, the European central bank, and the U.S. Federal Reserve have engaged in stimulus schemes to bring the global economy back to life. Primarily, the U.S. effort was intended to resurrect the U.S. economy.

The hope was that by buying all this public debt, enough of the money would actually end up in Main Street and produce jobs and real economic activity. It is debatable whether or not this actually happened. What is indisputable is that trillions of dollars were spent. A huge chunk of that money ended up in the equities market. This is why the Dow Jones racked up several record highs last year despite the fact that the economy remained soft.

Without economic stimulus and without all this cheap money floating around, the classic investor reaction would be to buy gold. Gold is the classic global store of value. It is also a safe refuge in uneasy economic times. Well, gold isn’t going anywhere. A lot of gold bugs are saying that gold will break out. Well, it has had its runs up and it has had its crashes. It seems to be trading sideways. What is going on?

The answer lies in cheap money. There is just so much cheap money out there. Even if a lot of investors plow their money into gold, the equities growth will still outpace gold. Since investments are purely comparative, it is no surprise that gold looks like a loser.

The truth is that the artificially inflated equities market is a classic study in moral hazard. By flooding the financial markets with all this cheap money, central banks’ stimulus schemes are incentivizing global investors to take unwise risks. These are risks that they wouldn’t normally do if they didn’t have all that money to fall back on.

Expect these to all blow up sooner or later. I suspect that either a tech bust or something related to the strong dollar will do it. Regardless, the house of cards will come down and, according to David Stockman, this might prove to be the final repudiation of central banks’ interventionist policies. Put simply, trying to fix the problem created by a crashing real estate bubble is worthwhile. But the solution is not creating another bubble using stimulus money. You might be creating bigger problems down the road. In many cases, the cure is worse than the disease.

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