Back in the days of the gold standard countries competed to show their commitment to “sound money”. Nowadays, the competition is in a different direction: to create more money and weaken the currency. Brazil’s finance minister has talked of an “international currency war”. Dominique Strauss-Kahn, the head of the IMF, this week warned against using currencies as a policy weapon.
Wishing that your currency would decline is not the same as making it do so. The old tactic of cutting interest rates has been pursued almost to exhaustion, although Japan lowered rates to a 0-0.1% band this week . But it is hard to create much of a yield differential within the developed world when rates are at or below 1% almost everywhere.
Intervention has been pursued in the rich world by both the Japanese and the Swiss. But intervention works best when central banks co-ordinate their purchases, and which country is going to help another to devalue?
So that leaves the option of quantitative easing (QE), or creating more money to purchase assets. This is largely presented as a tactic to stimulate the domestic economy by lowering the cost of finance and putting more money into the banking system. But the creation of extra money in one country ought also, other things being equal, to drive down its price in terms of other currencies.
Over the past two years much of the developed world has attempted some form of QE. (The European Central Bank has done less than its rivals, which may help explain the euro’s relative strength.) Some see this as competitive QE, a game of “I can print more money than you can”. Many investors believe the Federal Reserve will be forced into another round of QE, perhaps as soon as November.
The prospect of further QE helps to explain why gold, equities and government bonds are all performing well at the same time. Gold bugs are buying bullion for the understandable reason that central banks appear committed to printing more money: they fear that eventually this will lead to inflation. Stockmarkets are buoyant on the grounds that QE will eventually work to revive the economy and head off the prospect of a double-dip recession.
Meanwhile government-bond yields have fallen because central banks seem to spend most of the QE money buying their own country’s debt. Traders see the central banks as putting a floor under bond prices. So QE is a kind of magic bullet, helping all asset prices to rise.
That may help to explain why gold and Treasury bonds both performed so strongly in the third quarter, an unusual combination. Dhaval Joshi of RAB Capital, a fund-management group, says that there have only been four other quarters since 1980 when gold, equities and Treasury bonds have strengthened simultaneously.
Why aren’t bond investors reacting with more alarm to the process of money creation? One possibility is that, with inflation and deflation both plausible consequences of a debt crisis, investors are spreading their bets, buying gold as a hedge against the former and bonds as a hedge against the latter.
Another factor is different time horizons. Inflation may be the eventual result of QE in a few years’ time. But as Paul Abberley, head of fixed income at Aviva Investors, points out, in the short term the risk appears to be deflation. Bond-fund managers have to worry about their results over the next quarter, or the next year, if they want to retain clients. What happens in 2015 is almost irrelevant.
Nevertheless, it is doubtful whether the simultaneous strength of gold, equities and bonds can last much longer. Mr Joshi says the four previous periods of triple strength since 1980 were all followed by falls in Treasury-bond prices.
Nor are rising gold and equity prices necessarily compatible. David Ranson of Wainwright Economics has looked at the relationship between gold and stockmarkets since 1824. Some might think that shares, thanks to their links with the real economy, would do well in inflationary times. But that is not what the data show.
When gold was up by more than 20% over a five-year period, the median return from large-cap American stocks in the same era was just 2.1%. And when gold fell by more than 20%, the median large-cap return was 99%.
Although asset prices may be buoyant at the moment, there are other risks ahead. Competitive devaluation is an inherently unstable system. Someone must lose their share of world trade. And a policy of boosting exports can all too easily turn into a policy of blocking imports.
