The response to the credit crisis is now being driven by politics more than the bankers. In the US, the priority for congress was protecting the pensions of the majority of middle-class Americans with savings in capital market instruments. Annual 401K statements showing the impact of the stock market crash on pension funds are due at the end of October. They will record lower figures than savers want. But the $700bn financial rescue plan seems to have prevented a share meltdown and will save many jobs on Capitol Hill.
Popular politics helps explain why Europe will fail to forge an equivalent response. Most pensions in France, Germany and Italy are financed through pay-as-you-go schemes.
All are underfinanced, but the average taxpayer in these three countries has no idea of what is in their pension fund. The pressure for a government bailout seen among US voters with their eyes on the index has not been repeated in most of Europe.
In the UK, in contrast, a substantial proportion of the population is acutely conscious of the inadequacy of the state pension scheme. They have been saving for years, principally in the value of their homes.
Few things could be as disastrous as sharp further house price falls for Britain’s Labour government, facing elections no later than May 2010. The priority for UK Prime Minister Gordon Brown is measures that halt the developing housing crisis. Top of the list will be interest rate cuts, even if this leads to further sterling weakness.
With the dollar and sterling falling, countries seeking to fend off the impact of the credit squeeze will be obliged to seek their own competitive exchange rate adjustments. This, not mass unemployment, will provide the most compelling parallel with what happened as the world struggled with intensifying depression in the early 1930s.
After helplessly watching output slump and dole queues grow for two years after the Wall Street crash, European governments decided to break with the prevailing economic orthodoxy by opting for devaluations.
In October 1931, Sweden abandoned the gold standard and was quickly followed by the rest of Europe. The US, which technically did not have a gold exchange rate peg, nevertheless acted to make the dollar more competitive by raising the price of gold in 1933-34. Some say that the recovery of the US economy began at that point.
There is an echo in our own times. Governments, under pressure from voters, will seek to mitigate the impact of the financial crisis by increasing the money supply and letting exchange rates decline even if that means higher inflation. This will erode the real value of equities and housing.
But the pain will be spread over time and will be less politically lethal than allowing a sharp one-off adjustment as some were forecasting before US Treasury Secretary Hank Paulson’s plan was unveiled in September.
It looks like money and property are poor options for investors seeking to protect their wealth. There is an alternative. Gold, and silver to a lesser extent, is in limited supply whereas money can be created if governments want.
This is already evident in the trend in gold prices. The metal was trading at about $840 an ounce on 6 September compared with $250 in the spring of 2001. Some forecast that the dollar gold price could rise by at least 10 per cent in the next six months.
As ever, there will be implications for the Gulf. The first is that the forecast global reflation will help underpin oil prices and maintain the region’s solvency. The second is that Gulf exchange parities will again be called into question.
The recovery of the dollar since last November helped ease pressure for revaluation. But a new pattern is now in prospect that may be more profound. But this time, eyes will be on gold not the dollar.