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Professor Lew Spellman, from the McCombs School of Business at the University of Texas at Austin, has an interesting new post out on the changing role of gold in the global economy.
It relates to the notion that a shortage of safe assets may be driving an epic hunt for “safe collateral” — driving down yields on traditional fixed-income investments — because there are more debt liabilities/obligations than safe collateral in the system.
In a zero-yielding environment like this, he believes gold begins to look remarkably attractive. This is especially the case if gold remains a liquid store of value, which is widely accepted as collateral across the system. What’s more, there’s little to differentiate it from a zero-yielding Treasury bond. In fact, the Treasury bond eventually expires, while gold doesn’t.
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.
What does this tell us about what’s happening to the global financial system?
In Spellman’s opinion, it seems to indicate that the market may unwittingly be moving towards a collateral-backed global currency (of its own accord). Possibly, even, 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.
At FT Alphaville we’ve played around with the idea of a global mind-meld towards the re-collateralisation of the system’s liabilities before. It’s a theory that we would say explains a lot. Though the best way to think about it really is like a giant game of musical chairs. While the music is playing, nobody cares about there being a lack of chairs. Probability wise, the impression is that almost everyone will be able to get a chair if and when the music stops.
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” their 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 thus 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.
See why ‘the debt-to-safe asset ratio’ may be worth paying attention to?
Related links: 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
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