The price of everything

Don’t bank on it

“If we didn’t have bonuses, we wouldn’t have had anybody working for us.”

-      Drexel Burnham Lambert spokesperson, explaining why the company gave over $195 million in bonuses just before it filed for bankruptcy.

Time was, any self-respecting bear had to rummage hard through the financial papers to find evidence for their base case scenario of looming financial sector implosion. Admittedly, such venal conduct is frowned on by the behaviouralists, who call it “confirmation bias”, which is evidently a bad thing (even if the apparent “bias” turns out to be correct). The point being, all a self-respecting bear has to do nowadays to find evidence of imminent armageddon is simply: open the paper. Wednesday’s issue of the Financial Times was a case in point. Gillian Tett published another report from her consistently excellent coverage of the credit crisis (“Draining away – four problems that could beset debt markets for years”). Any reader who survived that account only had to turn the page to read Martin Wolf’s related discussion of the current financial crisis: “Why banking remains an accident waiting to happen”. One can only take issue with the tense: banking as accident has already happened, although admittedly it can and probably will get worse. Equity market investors can in any case no longer use the excuse that credit market problems weren’t entirely in the public domain – try and read any broadsheet without stumbling upon ever lengthening coverage.

Readers who would like to take issue with any of the above will have their work cut out but are wholeheartedly invited to do so – there is altogether too much confirmation bias going on. Perhaps the only saving grace from the current financial débacle is that, in time-honoured fashion, the ‘nouveau riche’ have stepped up to the plate to bid for assets that anyone with any taste or discernment has quietly abandoned. And so we read that Middle Eastern and Asian sovereign wealth funds have “invested” roughly $37 billion in shares of western financial companies this year. This could yet be akin to those Japanese purchasers like Mitsubishi Estates in 1989 who “invested” capital in trophy assets like the Rockefeller Center in the late 1980s - at a level that nobody else was willing to pay - just in time for them to file for Chapter 11. Or perhaps ADIA’s $7.5 billion emergency cash injection into Citigroup will prove an astute investment into a fundamentally sound business rather than into an uncontrollable leviathan with unquantifiable junk exposure employing 327,000*; and perhaps China’s $3 billion investment into private equity group Blackstone this summer won’t prove ex post facto to be the top of a secular bull market in leverage and indiscriminate risk-taking.

Adding fuel to the fire of the deflationary crisis is CLSA’s Christopher Wood, whose latest ‘Greed & Fear’ newsletter draws attention to the worrying dichotomy between government bond yields (shrinking) and interbank lending rates (rising). This is worrisome because it points to a simultaneous flight to quality and from corporate and particularly interbank risk. Quite how long this lasts is an open question, but it seems a reasonable assumption that current credit market conditions have never been experienced by those charged with navigating their firms through them, let alone by those looking to surf them for material gain. Wood suggests that

“The unwinding of structured finance is causing an accelerating global credit crunch which threatens not only US consumption but also the vigour of the current global economic cycle. Meanwhile, the risk of market-moving financial accidents is rising daily, as shown by Citicorp’s desperate sale on Tuesday of $7.5 bn worth of equity units to the Abu Dhabi Investment Authority.

“All this is why it is only a matter of time before the Fed cuts interest rates again and why there will be, sooner or later, coordinated interest rate cuts which will include the Bank of England and the ECB and maybe (horror of horrors) even Japan.”

Sceptics would be tempted to ask why, therefore, the equity markets have been surprisingly resilient ever since the credit market’s long hot summer of hate first bubbled up to the popular consciousness. The answer, as Christopher Wood and others have increasingly pointed out, is that stock markets are much more stupid than bond markets.

(Just to add some more discordant notes to the mood music surrounding stocks, Craig Karmin for the Wall Street Journal suggests that a number of North America’s most powerful investors are planning or considering making substantial reductions in their US stock holdings, including the New York State Teachers’ Retirement System, the New York State Common Retirement Fund, the Teacher Retirement System of Texas and the Florida Retirement System Pension Plan, which in total control more than $500 billion in assets. Russell Read, Chief Investment Officer for the California Public Employees’ Retirement System (Calpers), suggested that the $250 billion fund might enhance returns by moving assets from US to foreign stocks, taking US equities from 40% to 24% of its portfolio – which would mark the fund’s lowest allocation to US stocks in more than 20 years. Calpers is due to consider the measure later this month. While this would represent a zero sum game for equity markets as a whole, it is difficult to see how huge withdrawals from the US market would leave foreign markets unchanged.)

On a related issue, given the sensitivities around the importance of banking in the modern economy, let alone around individual banks’ still opaque exposure to unexploded ordinance, the tit-for-tat assaults on banking competitors masquerading as research are a more than usually conflicted and  loathsome excrescence from Wall Street. Brokerage “research” – if issued from an investment bank with enough clout – can easily become a self-fulfilling prophecy, and even faster when markets are as badly dislocated as they are today. So it wasn’t much of a surprise that shares in Citigroup fell sharply after Goldman Sachs cut its rating to “sell” with fresh predictions of as much as $15 billion in writedowns relating to CDOs. That downgrade might have looked even smarter if it had been issued, say, when Citigroup was trading at $50, when Goldman’s opinion was “in-line / neutral” (whatever that means), rather than the $32 at which it was actually released to a no doubt grateful world. The writers of ‘Long or Short Capital’ have a wicked line in brokerage tit-for-tat downgrade parody:

“In November.. Citi downgraded E*Trade and set a 15% chance of bankruptcy. Goldman Sachs downgraded Citi to a sell, forcing Citi to later downgrade Goldman from a strong buy to a mild buy.. Merrill Lynch has made plans to downgrade Goldman because of its heretofore unrevealed defence pact with Citi, but they are looking internally for a way to resolve it in the context of their downgrade non-proliferation treaty with Lehman and Goldman. Bank of America has been skating by nicely, but has its downgrade silos “hot and ready”. CSFB, in a defensive move, has.. been firing downgrades at all comers.. JP Morgan is sitting on the sidelines, just happy no one has noticed how ****** they really are. Bear Stearns has been downgraded to the point of not actually existing..”

But downgrading rivals – even in an environment of heightened investor doubt – remains childish compared to the damage that banks have managed to inflict upon themselves (and their shareholders, always the last constituency amongst any financial institution to get fed). As Martin Wolf writes, the combination of generous government guarantees (as lenders of last resort) with rampant profit-making¹ in inadequately capitalised institutions is an accident waiting to happen again and again:

“Either the banking industry should be treated as a utility, with regulated returns, or it should be viewed as a profit-seeking industry that operates in accordance with the laws of the market, including, if necessary, mass bankruptcies.”

Shareholders in Northern Rock, and investors in equity markets wondering what all the credit market fuss is about, please take note.

*as at 31.12.2006. Whether this is a good deal for Citi or for ADIA has been covered well and extensively elsewhere. Suffice to say that we prefer to stay on the sidelines with regard to financials, even those deemed “too big to fail”. They said that about The Titanic, didn’t they ?

¹Something banks were apparently doing until the subprime crisis broke.

Viene la tormenta

“There are none so blind as those who will not see.” – Anon.

So far, so bad. The fear continues to spread across disparate markets and asset classes. Interbank market-making of covered bonds gets suspended because nobody wants to be left holding a bag that might contain a bomb. The bids don’t work – they just make you worse. Property funds take a leaf out of the hedge fund playbook and start to impose three month delays on redemptions. Property firms warn of an overvalued market. AIM flotations are pulled. Banks step in (probably reluctantly) to maintain the credit ratings of bond insurers. On the basis of last week’s early price action before the Thanksgiving break, equity investors have finally woken up after a ‘Rip Van Winkle’ sleep of baffling length and complacency, and have come to appreciate that prospects for investment markets really have changed, after all. The summer of 2007’s credit market problems were never restricted to that ludicrous euphemism ‘subprime’. Rather, as pi Economics’ Tim Lee suggests,

“..subprime is merely the first part of the credit edifice to give way, not the whole story.”

As Tim Lee has it, as the credit bubble inflated, the global economy appeared superficially robust. Surging imbalances were financed by too much easy credit. This was not just in the housing market. In April, for example, we alluded to the robustness of American Express’ consumer lending policy:

“As the membership criteria at American Express remain stringent, the Rewards Plus Gold Card is difficult to acquire for all but the most financially disciplined.”

So went an application letter from the US credit company. Not to Annapolis resident Marilyn Hecox herself, but to her four-year-old pet cat. Ms. Hecox had already received credit invitations for her children and her late husband.

And housing price appreciation allowed personal savings rates to plumb new shallows without impoverishing consumers. That was then. As Tim Lee also points out, credit growing well in excess of income (middle Americans were never beneficiaries during the boom like the multi-millionaires not so busily running Wall Street brokerages into the ground) requires permanent rapid asset price inflation, or generalised inflation. Unhappily for the Fed, the US economy (along with others) now has none of the former and plenty of the latter.

Tim Lee suggests that in the context of a fully fledged credit bust, “we have merely seen the opening act”. That is consistent with the viewpoint of a Japanese equity long/short manager who suggested to us several years ago that whereas Japan in the 1990s had been the dress rehearsal, the rest of the world would soon be the main event. Tim points out that there are already clear signs of an incipient deflation (commodities and natural resources prices notwithstanding, and they may be temporarily topping out) – whenever house price inflation has been significantly below consumer price inflation the economy has always been in recession and inflation has been set to fall. The only wrinkle in this macro view is the role played by a newly resurgent gold price. But the strength of the gold price can be reconciled with a) a growing fear of something among global investors that can be roughly approximated to armageddon, b) the impact of trend-following or otherwise speculative capital and c) growing fears about the purchasing power of the US dollar but also of other fiat currencies backed by increasingly flimsy economic fundamentals.

As to gold, an extensive research piece by Paul Mylchreest of Redburn Partners, ‘Gold War’, posits the following thesis:

“The biggest credit bubble in modern history is showing signs of unravelling in the US. Debt / credit expansion brings forward consumption – it must either be purged in a deflationary recession, or inflated away through currency debasement. Gold wins in either scenario and is the ‘go to’ asset along with basic commodities, like food and energy.”

Redburn’s Paul Mylchreest points out that the long run average for the gold / oil ratio (the gold price divided by the price of Brent crude) has been approximately 16 times. It is currently 9. On the basis of mean reversion, either oil is too expensive or gold (even at $800 per oz) is too cheap, or both.

As we know from experience, merely mentioning gold as a relevant portfolio component tends to trigger accusations of philistinism or quackery, or some virulent combination of the two. Which is acutely unfair: nobody refers to ‘money bugs’ or ‘wealth bugs’, after all. Hostility to gold probably comes about through the inevitable human process of extrapolation (what hasn’t worked for two decades will evidently never work again) and a touching credulity with regard to financial innovation. In any case we see much to empathise with when Tim Lee suggests that

“we are presently at one of the rare defining moments in financial history, a time that will be referred to forevermore by economic and market historians, much as is the Wall Street crash of 1929 or the credit and banking crisis of 1973-4.”

But as Tim says, up until recent weeks it has been difficult to detect as much from the attitudes of investors, particularly stock market investors. Analyst Nouriel Roubini makes Tim Lee look like a bull. Having accurately predicted the US housing hard landing, Roubini goes on to admit that he now sees

“the risk of a severe and worsening liquidity and credit crunch leading to a generalised meltdown of the financial system of a severity and magnitude like we have never seen before.”

In the final analysis, investors will position themselves on the basis of their emotional make-up. Optimists will believe that accommodative anglo-saxon monetary policy will outweigh a deteriorating housing and financial sector. Realists will fear the worst, and make the appropriate adjustments to their overall risk allocation.

But many investors, as we suggest, are now rousing themselves from a long and negligent sleep, and seem suddenly determined to do something to make up for lost time. The Financial Times’ fm supplement last week cited figures from Lipper Feri Fund Market Information: the European fund management industry saw net outflows of €79 billion in the three months to September “with virtually every asset class coming under the cosh”. Such outflows are unprecedented. Diana Mackay of Lipper Feri commented that

“this is not just an equity issue, it pervades a lot of asset classes. I think we are headed for a lean period.”

Such plain speaking from financial services professionals is rare. We have consistently advised investors over recent months to rein in their animal (and particularly equity-related) spirits in the face of an increasingly obvious approaching squall. At the conclusion of James Cameron’s ‘The Terminator’, Sarah Connor vanquishes one foe only to drive unwittingly toward an even deadlier threat. As the film’s last lines attest: viene la tormenta. There’s a storm coming in.

Old Mother Shipton and the Mystery of the Markets

“The future will be better tomorrow.” – Dan Quayle.

America has its groundhog. France has Nostradamus. Morgan Stanley has Teun Draaisma. Now we can exclusively reveal that Harrogate’s very own prognosticator of prognosticators, wise woman and seer Old Mother Shipton, may have foreseen this year’s credit crisis and much more. A fragment of parchment recently recovered from Knaresborough’s Petrifying Well alludes darkly to some of the arcane secrets of the modern market which may have been written some 500 years ago. Scholarly interpretation and explication is included in the footnotes below.

“..And now a word, in simple rhyme

Of what shall be in future time¹.

A span of green² will lose control³

Time to buy bituminous coal.

Greenbacks then will flood the street

And barbarous metal6 will compete.

In the east the hordes will rise7

Seeking out yet more supplies.

The price of crude oil will rise fast

(That Citigroup’s oil team won’t forecast.8)

The housing market will grow ill

From Pembroke Pines to Primrose Hill9

You know me as Old Mother Shipton;

Word to the wise: avoid the Skipton.10

For lenders big and small shall fail,

And credit analysts end in jail.

A badger11 will take quite a knock

From overseeing Northern Rock.12

Credit traders, take your time

Short ABX and short subprime.

In 2007, as it is writ

Banking shares will be worth nothing.”

So there we have it. The perfect tour d’horizon of the 2007 macroeconomic environment, pausing for consideration of all the major themes: emerging market growth and inflationary pressure, the decline of the dollar and the associated rise of gold and precious metals, the housing market and interbank lending crisis, and the merits of infrastructure investments. Not bad for an old woman who lived in a shoe!13

¹A particularly crass rhyme. You can tell this woman lived in a cave.

²Likely a reference to Alan Greenspan, former chairman of the Federal Reserve and now fulltime annoying blow-hard.

³(of the dollar, presumably)

Intriguingly specific; more likely a blanket recommendation to invest across the commodities and natural resources complex.

Again hints darkly at some form of money and fiat currency crisis, originating in the US.

6Probably a reference to gold, cf. John Maynard Keynes’ “barbarous relic” jibe.

7Likely a reference to the 1.3 billion population of China and the 1.1 billion population of India, the next line anticipating their inflationary impact upon the prices of foodstuffs and raw materials.

8The inability of Wall Street in general, and Citigroup in particular, to make accurate predictions about the price of oil is well documented, notwithstanding the fact that they have been known to maintain multiple price targets from different departments just to hedge themselves and confuse everybody.

9i.e. from the US (Florida) to the UK (London) and elsewhere. One has to admire Old Mother Shipton’s eerie pre-emptive grasp of the international scope of the 2007 real estate bubble.

10Old Mother Shipton anticipated the late summer credit market and interbanking lending crisis but sadly chose the wrong building society.

11Thought to be a reference to UK Chancellor Alistair Darling, who does look a bit like a badger.

12Though she later identifies the right one.

13Cave, actually – Old Mother Shipton.

Money Will Eat Itself

“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

-      Thomas Jefferson, Letter to the Secretary of the Treasury Albert Gallatin, 1802.

Karl Marx would have been proud. The author of ‘Das Kapital’ held that the capitalist economic cycle was prone to increasingly severe crises, and that the need for a constantly expanding market would ultimately cause the system to collapse upon itself. But the extent of the current financial emergency is playing out like one of the more outrageous James Bond plotlines – only with Cold War spies replaced by frostbitten banks. The most resourceful member of SMERSH would have been hard pressed to inflict more damage on the western financial system than its banks have managed on their own, whether via venal lending or by comparably facile investing. We have, of course, been here before. Nassim Taleb pointed out in ‘The Black Swan’ that after defaults in Latin America,

“In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking – everything.”

And history seems to be repeating itself, to the extent that the Savings and Loan crisis of the 1980s, in which a real estate bubble was a proximate cause, led in turn to a slowdown in financial services and property markets that triggered recession in 1990/91. Markets of course are more efficient today – so the recession should appear more quickly than in the past. We have yet to experience a full-blooded systemic collapse, but in some markets the distinction between a collapse and a wholesale evaporation of liquidity is moot. Wall Street has cunningly avoided a fire sale in the grisliest mortgage products by simply refusing to trade them altogether. But feigning illness does not defer the maths test indefinitely. Last week, equity markets finally woke up to the reality that has been plaguing credit markets all summer and a growing sense of foreboding finally replaced wholly irrational complacency. Just to leaven the prevailing sense of gloom, jittery markets have been accompanied by sporadic moments of high farce – the $161.5 million payoff for Merrill Lynch’s Stan O’Neal, for example, or the seizing up of the London Stock Exchange just prior to Wednesday’s close. Memo to the LSE: electronic trading systems are meant to buckle during a market meltdown, and not beforehand. Perhaps the outsized payment for the former Merrill boss is confirmation of Wall Street’s own secret fears about the dollar – that it is essentially worthless, in any quantity. Perhaps the mountains of cash being shovelled at rent seekers throughout the market free-riding off other people’s (leveraged) capital reflect a fin de siècle black joke by the forces of karma, just ahead of the ultimate collapse in the value of all paper money. As Brady Willett understatedly puts it,

“If investors head to the safety of gold en masse during a major financial crisis, the global financial system as we know it ceases to exist.”

For some, that might be no bad thing – particularly if continuation of the status quo involves an international banking market where banks no longer trust each other enough to lend, where investment banks go from ‘marking to market’ to ‘marking to model’ and end up ‘marking to make-believe’, and where central banks can be counted on to “rescue” Wall Street interests if they only bleat loudly enough. And where the noise of property market-related shoes dropping will soon, quite probably, be deafening.

China did its own bit for demolishing its own portfolio value contributing to the currency debate when Cheng Siwei of China’s National People’s Congress suggested that, “We will favour stronger currencies over weaker currencies, and will readjust accordingly,” and when Xu Jian of the central bank observed that the US dollar was “losing its status as the world currency”.

Market timing is admittedly fraught at the best of times, but the chorus of dollar bears (ourselves, admittedly, lilting from the sidelines) is now deafening enough to warrant a vicious counter-trend reversal. And while one acknowledges that the US economy remains, in the words of Accrued Interest, “amazingly dynamic”, the stock market and the economy are not quite the same thing, and the stock market function of discounting future trends (namely a deteriorating property market, less “wealthy” consumers and thus less consumer spending, and the possibility if not probability of recession) seems to be broken – like so many other functions of the capital markets. And given the ongoing poor visibility of both losses and future revenues, it is still too soon to be buying financials.

All of which makes the challenge of capital preservation in real as well as nominal terms exquisite. At what point does central bank capitulation to the markets in the form of lower rates actually detract from government bonds inasmuch as it uncorks the inflation genie from the bottle ? Academic question perhaps - this genie is in any case already at large. The benignly disinflationary impact of Asia on western asset markets has gone into reverse. Jeff Matthews quotes from ACCO Brands’ most recent quarterly earnings call:

“..within China, we’ve seen significant labour inflation, coupled with a reduction of what used to be what I’ll call start-up incentives that were given through Chinese VAT. Those.. plus the significant labour inflation is starting to cause an inflationary spiral coming out of China which you can then couple with the flotation of the Yuan with the US dollar.. So, my biggest concern from a price pressure point of view right now, is China followed by oil and its trickle down effect to all the other commodities and energy..”

Jeff Matthews adds, somewhat archly,

“So the only price pressures ACCO is seeing are:

1.    “An inflationary spiral coming out of China”

2.    Oil

3.    “All the other commodities”

4.    Energy

5.    Ocean freight.

Other than that, I guess the Fed has it all under control !”

So the ‘fright to quality’ argument underpinning government bonds is undermined by the inflationary aspects of a) weaker fiat currencies, b) hard assets, c) China and d) baffled central bankers taking direction from the likes of Jim Cramer. Cash has already largely disqualified itself. Inflation-hedging then, perversely, comes in part from the very assets that are already exploding in price – resources, particularly gold and oil. Property would, under normal circumstances, be an alternative, but in most developed markets it now looks like a sick joke. Perhaps the recent strength of equities is less of a surprise, after all. But it is unlikely to be a lasting one.

Just an illusion

“Fiat currencies don’t float. They just sink at different rates.” – Unknown.

Money illusion affects people, and markets, in different ways. The primary form of money illusion, of course, is that we always believe we have more money than we actually do – too much month left, in other words, at the end of our money. Other current examples of money illusion include thinking that a 2 bedroom flat in Chesterford Gardens, Hampstead is worth £1,400,000 in September when it isn’t selling in November for £1,200,000 (according to PropertySnake). Or that the fair market value for responsibility for an $8 billion writedown and the biggest quarterly loss in your brokerage’s 93-year history is an early bath bonus of +$161.5 million. (To be fair to Stan O’Neal, when he promised in December that Merrill Lynch’s $1.3 billion acquisition of subprime mortgage lender First Franklin would provide “revenue velocity”, he didn’t explicitly state whether those increasingly rapid revenues would be positive or negative, though now we know.) But perhaps the most dramatic form of money illusion is the belief that a 2.6 inch x 6.1 inch 1 gram rectangle of linen and cotton that costs 4.2 cents to manufacture and that represents ‘money’ without any material backing is worth anything at all.

Financial markets have started to get wise to this ‘money’ fabrication business. One might almost say that this process of enforced wisdom-getting has accelerated. The ‘velocity’ ((c) Stan O’Neal) of ‘money’ may be increasing, but its direction would appear to be: downhill. Say you want to invest your ‘money’ in a barrel of WTI crude oil. In 2002, you would have needed to part with 20 of your 1 gram rectangles of 25% linen, 75% cotton. Now, to buy the same barrel of oil, you need to part with over 90 of those same rectangles. Of course, given that the composition of this barrel is unchanged, the apparent deterioration in value of those rectangles probably makes you happier to part with them to exchange them for something at least more tangible and economically useful. “Parting is such sweet sorrow,” as that great behavioural economist Shakespeare once wrote. Amazingly, we can also use these rectangles to purchase finite assets with a several thousand year history of acting as a store of value though admittedly, now that everyone has woken up to this rectangle depreciation story, it costs more of them to do so. Seven years ago, you could have bought an ounce of pure gold with just 257 green rectangles. Now it takes almost 800 of them to secure access to that same ounce. It’s as if the market had belatedly discovered that green rectangles and money were not necessarily the same thing.

The prices of other assets as expressed in green rectangles have also been on the rise. As Manuel Hinds and Benn Steil reminded readers in last week’s Financial Times (“History’s warning about the price of money”),

“People react to the “growing insolvency” of a reserve currency, such as the dollar, by acquiring “gold, land, houses, corporate shares, paintings and other works of art having an intrinsic value because of their scarcity”.. Indeed, this is the story of our present decade, one in which alternatives to the dollar as a store of value have soared even while the CPI has remained subdued.”

It is the reference to the CPI that throws you off your stride. Notwithstanding the hedonic adjustments and other statistical legerdemain that have created inflation ex-inflation, official inflation rates, that handily excise troublesome price rises in obviously trivial sectors like food and energy, have been the dogs that haven’t barked. Yet. As Hinds and Steil point out, there are historical precedents:

“This phenomenon is well-known in developing countries, where asset booms combined with low CPI inflation have preceded monetary and financial crises. In Mexico, for example, share prices rose 12-fold between January 1989 and November 1994, while inflation fell from 35% to 7%. Inflation then soared as the Tequila crisis exploded.

“Prices of shares and real estate more than doubled from 1993 to 1996 in Indonesia and South Korea while CPI inflation rates were declining. In May 1997, just weeks before the currencies collapsed, inflation was only 4.5% in Indonesia and 3.8% in South Korea.”

Comparisons between Indonesia and South Korea on the one hand, and North America on the other, are obviously unfair. Investors are queuing up to invest into Asia. Notwithstanding the recent flood of foreign investment, we are a long way from the end game there. Less so for the US, whose currency is being dumped by legions of investors in favour of euros, shares, oil and gold. Not to worry, though: the US Treasury Secretary reminded investors last week that the United States is committed to a strong dollar policy. He just didn’t say whose dollar.

To this extent, the extraordinary bull run by equities in the teeth of a US property market slowdown, in the midst of a significant dollar depreciation, and in the face of a raging gale in credit markets is explicable, inasmuch as it reflects the last gasp of investors determined to spend their rectangles on something, indeed anything, as opposed to other rectangles.

History may not repeat itself, but previous events set an ominous precedent. As Hinds and Steil also point out, between August 2001 and August 2007, the dollar price of gold rose by 144%, versus a rise in CPI of just 17%. In two periods, from 1971 to 1975 and from 1977 to 1980, “the increase in the price of gold and other commodities presaged substantial increases in CPI inflation as well as significant falls in the international value of the dollar.” While the dollar then survived as the least-worst standard of value, it did so in part because of Paul Volcker’s discipline (as opposed to Greenspan’s and Bernanke’s indiscipline) at fighting inflation, and in part because no other currencies were up to the task. We now have a world of euros (and, ultimately, yuan) and a liquid supply of gold – what Hinds and Steil call “a viable private alternative that has permanent intrinsic value”.

The Weimar era hyperinflation is not the only example in Europe of currency value dwindling away into absurdity, nor is it the most recent. In Yugoslavia by the early 1990s, the government had exhausted its hard currency reserves and started pillaging the hard currency savings of its citizens. Restrictions were imposed on private hard currency savings in government banks. There was a run on all goods, notably gasoline. All government gasoline stations were eventually closed and gasoline became available only from roadside entrepreneurs operating a) a parked car and b) a plastic canister of gasoline. According to Thayer Watkins of the Department of Economics, San Jose State University, this gave rise to at least one tragic episode. After repeated attempts to withdraw his Deutsche Mark deposits from a government bank, one man announced that he was going to kill himself in front of a government building by dousing himself with gasoline and setting fire to himself. On the appointed day he turned up with a canister of gasoline. The media were in attendance. As were the police, who promptly arrested him. Soon afterwards, the television station received a number of calls asking what had happened to the canister of gasoline. In another alleged incident as the supply of goods continued to diminish, someone passed by a queue of pensioners waiting in line for mundane supplies. This person was carrying bags of groceries from the free market. Two pensioners got so upset at seeing someone else with household goods that they had heart attacks and died on the spot. By the end of December 1993, the exchange rate was 1DM=3 trillion dinars. By January 4 of 1994 it was 1DM=6 trillion new dinars. The government then announced a new new dinar equivalent to 1 billion of the old dinar. By mid-January the rate was 1DM=700,000 new new dinars and soon 10 million new new dinars. On January 24 the government introduced the super dinar, equivalent to 10 million new new dinars.

All of which is not to suggest that the US dollar is going to go the way of the old dinar, only that in matters of fiat currency even more than in commodities, price changes can go further and faster than ever seems remotely possible in reality. Until such time as the Bush administration genuinely engages with an ever-weakening dollar (“our currency, but your problem”, in the words of the Nixon administration), investors will find some solace in inflation-protected debt and precious metals.