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Cash Is King - Or Is It?Cash is King. Or is it? Last month, in this newsletter, I mentioned the performance of a number of assets that have been performing well through 2003. Among them, I talked briefly about currencies and commodities. Several people have since asked me to try and explain myself in a little more detail. In other words, they asked, "why?". Well, here goes... In my opinion, much of the growth is due to the actions of the leading central banks and governments. As you know, I keep banging on about the massive expansion in debt of the American government, but they are not the only offenders. In his last budget report, Chancellor Gordon Brown explained how the rising costs of going into Iraq will cause him to need an extra £10 billion, taking the borrowing for the year to £38 billion. If the UK had joined the Euro, this would have caused borrowing over and above the predetermined limit of 3% of GDP (as established by the Stability and Growth Pact). Within the Euro zone, both France and Germany have exceded the 3% limit and anticipate that they will do so again next year. (As you may have read, within the Pact, it is possible to 'fine' nations up to 0.5% of GDP per year that they overspend, an idea which seemed to be just dropped and the European Commission has launched a legal challenge). These are the two largest Euro economies and excess borrowing from these nations could cause major problems. But worse is to come! It is forecast that next year there will be overshoots of this 3% rule by Portugal, Italy and the Netherlands. (I have been willing to tell just about anyone that asked me over the past five years that a single currency for an entire continent with so many nations is a bad idea. Politically, it has been a masterstroke, forging a new European unity and making the movements of citizens far more straightforward. The economic reasons however, are less rosy. Sooner or later, a one size fits all interest rate will cause massive problems within some far off corner of the EU. My fear is that such a scenario will only become an issue when such a situation hits national politicians and can see and feel the effects in their pockets every day. This could take years or even decades for the full effects to become known. If it does, remember that I mentioned it here in 2004!) I'd like to offer a quote (stick with it, there is quite a bit here even though I have removed several sentences for brevity): "For in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees dimished the real quantity of metal, which had been originally contained in their coins. By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfill their engagements with a smaller quantity of silver than would have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor..." That gem is from the superb, The Wealth of Nations (Book 1), which is by Adam Smith. It was the birth of economics as we know it, from 1776. I highly recommend it. If ever you want to have a better understanding of the world it is a great place to start. I'd like to make room for a quick apology to Steve. Not only did I read it - humiliating him - on flights to and from Ibiza last summer, (everyone else on the flight was reading The Sun) but now I am quoting from it. I'm sorry mate, next time I'll get FHM like everyone else. Sorry, I digress... With state borrowing increasing from an historic high point, the major western currencies look less enticing. So where would you keep your money if you were a fund manager? The answer is almost anywhere but cash. Almost any asset you can think of is likely to outperform cash over the next two to three years. That will, and already has, cause a flood of money back into the traditionally liquid assets (the ones that can be bought and sold most easily) and so share and commodity markets face a sudden supply and demand imbalance. Up they go. A great example of this, is gold. History has shown that it is THE store of wealth worldwide. When the waters ahead look choppy, the 'smart money' makes a run for it and more often than not, this has had them flocking to buy bullion in one form or another. Currently, gold has a number of very positive signals which indicate huge potential demand in the future. As the bullion worldwide is being sold by central bankers it is moving into the hands of the people (and into some nations far more than others). For an example of what I mean, price wise, have a look at this link:
As you will see, it is the average price of gold, in US dollars, since 1900. Look at how the graph is heading upwards over the last few years. Quite an increase in price isn't it? Things like that only happen for one reason, supply and demand. Since we know that the European central banks have been selling 400 tons each year and will soon be increasing that to 500, someone must be buying. It isn't America, they are selling too. 400 tons may not sound like a lot, but when you consider the cost of an ounce, multiply that up and it soon is a lot of money. All I know for sure is that neither of my calculators can handle a number that big! Where does all of the above leave us? With just one conclusion, that at times in the economic cycle, cash can be a good investment or good protection. At other times, cash is one of the least profitable investments you can have. I'll say no more. * This was first published in February 2004 *
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