Gold, Recession and Why Britain’s Winning the Currency War

Britain's on the right track on currency issues

    View All  

Depending on how you look at it, the Bank of England’s doing its job brilliantly…

Preliminary data released this week show that Britain has fallen back into recession. UK GDP shrank for the second consecutive quarter in the first three months of the year, meaning Britain’s first “double-dip” recession since that 1970s.

In truth, this was not unexpected. Nor was this week’s other news that UK government debt continued to rise in the year to March, hitting 66% of GDP according to the Office for National Statistics.

Nonetheless, with debt growing and the country seemingly as far away from a meaningful recovery as ever, it seems an appropriate time to consider the likely environment British investors will face over the next few years – and what it all might mean for anyone who has made a gold investment.

We have noted before that there are five ways a government can deal with its debt:

  1.  Economic growth – The only meaningful claim a sovereign has on being able to repay is its power to tax. This claim becomes wobbly when the economy from which tax revenues are generated stagnates;
  2.  Raise taxes – Aside from this being counter-productive, slow or negative growth makes raising taxes very difficult politically;
  3.  Borrow more – Repay and service existing debts by taking on more debt. In practice, there tends to be a limit to how much investors are willing to lend countries. And, as we’ll see in a moment, that limit can be hit suddenly and with little warning;
  4.  Inflate – Repay, but in money that’s worth less than when you borrowed it. Generally this option only applies to debts denominated in domestic currency and where a country has control of its own monetary policy;
  5.  Default – Just don’t pay.

Traditionally, a government like Britain’s has managed its debt through a combination of the first four measures. Bondholders would prefer the government to use only the first two. The third is less-than-ideal since it can lower the value of bonds already in circulation. The fourth and fifth clearly impose real terms cost son lenders.

When an economy hits bad times – as Britain’s has – the balance shifts and borrowing and inflation do more of the work, simply because the first two measures are not feasible. This is the environment British investors can expect in the years ahead. It’s the one we have now, in fact, just dragging on and getting incrementally more intense.

But what’s the endgame? Where and how will this crisis end?

The short answer is it will most likely end the way all such crises end: with the creditors paying the bill.

How exactly will this happen? To be blunt, we don’t know. No one does. But we can hazard a guess.

Policymakers will try to steer a nervy course between two rather unpleasant possibilities: a debt crisis, such as that engulfing Europe right now, and out-of-control inflation.

Here’s a closer look at how those scenarios might come about.

 
1 2 3 4 View All

Article printed from InvestorPlace Media, http://investorplace.com/2012/04/gold-recession-and-why-britains-winning-the-currency-war/.

©2014 InvestorPlace Media, LLC

Comments are currently unavailable. Please check back soon.