Two Competing Theories. Among the most controversial conspiracies among financial market participants is the controversy over currencies and the related topic of inflation versus deflation risk. In one camp, prognosticators argue that central banks are fighting a valiant fight against deflation; the fight is considered valiant largely because global deflation was a dominant factor in the mid-1900s Great Depression and therefore a trend of declining asset prices should be prevented. In the other camp, the less mainstream voices assert that aggressive deflation fighting through monetary and fiscal expansionary policies merely delay inevitable reallocation of less efficiently-deployed capital and merely raise nominal price levels; longer-term, sustained increases in nominal prices at best enhance the per share earnings of publicly-traded companies, and at worst may drive increasing gaps in standards of living as low- and lesser-skilled workers' wages tend to rise more slowly than monetary-induced inflation.
So who is probably right? I am convinced that the latter group is correct, and therefore I have invested 40% of my liquid assets in the currency that prevails when the prices (or as economists put it "opportunity costs") rapidly rise in nominal currency: gold. I own gold in physical bars, asset-backed (not derivative-backed) gold ETF shares, and through stakes in gold mining stocks. In my view, gold likely has downside risk to $1000 (from recent prices near $1300) but upside of $10,000 given that the $3 trillion in excess U.S. bank reserves ultimately may be lent out approximately 10x given the current U.S. bank required reserve ratio of 10%. My $1,000 downside risk estimate is based on the face value of $4,000 trillion in "printable" U.S. dollars today compared with the approximately $1 trillion of printed U.S. dollars before the financial crisis, and given that gold was trading around $250 per ounce in the late 1990s. However, that $1,000 downside risk estimate is likely extremely conservative given that our U.S. banking system is a fractional reserve banking system in which one newly-lent dollar from a bank, can result is $10 of eventually-created new U.S. currency under current banking rules.
So what is the catalyst? Currently, some of the most desirable currencies in the world include the Japanese Yen, the Chinese Yuan, and the U.S. Dollar. There are possible good reasons for the preferred status of these currencies, including liquidity, tradition, government systems that value 'Rule of Law' and current widely-accepted business practices. However, the countries that manage these currencies are not rich in basic materials natural resources, and have steadily-rising or rapidly-rising debt service dynamics. While debt-to-GDP is a widely accepted ratio among financial market participants with regard to the fiscal health of a nation, debt service (the annual cost of interest and principal repayment requirements) expense risk is probably a more telling risk factor. The debt service expense risk of Japan, China and the United States is rising. I believe eventually this will become a consensus view and that will cause a global shift away from these currencies and toward the currencies of more resource-asset-rich countries, such as Australia, Canada, and others; perhaps fiscally-conservative nations like Switzerland will also experience investment fund inflows. However, those nations' currency liquidity and availability is much more limited than the existing preferred global currencies. Therefore, the ultimate long-term global history currency, gold, is likely to benefit from substantial inflows as well. While I cannot and don't even attempt to try to predict the timing of when this thesis will play out, global near-zero interest rates have lowered my opportunity cost of placing my savings into gold and related investments. Similarly, every investor needs to determine their own ideal investment allocation mix, but I believe that every investor should should consider whether there are any risk scenarios that their current portfolio allocations do not incorporate.
