The 1945-2007 period was wonderful in almost every way, particularly for investors and it was common to assume that this was “normal”. However, it was anything but in historical terms for many reasons. One of the most important reasons is that over most of those 62 years, there was a debt-fuelled artificial growth in incomes and particularly wealth in the form of housing and equity asset inflation (Chart 1).
There was the appearance, but not the reality, of stability. The debt bubble was driven by a combination of factors and high on the list would be government policy, the rise of an entitlement mentality, the decline of personal responsibility and the discipline and progressive weakening of banking governance, as regulation was dismantled.
As debt rose relative to GDP after 1980, the financial system and the economy became increasingly vulnerable to a shock. The crash of 2008-2009 marked the end of that era. The subsequent great reflation aborted a downward spiral and gave us a two year artificial recovery. In the process, it turned a private debt and banking crisis into a public debt and, in Europe, a second banking crisis.
The ability of governments to backstop the financial system, risk more generally, and to sustain entitlements is over. We are rapidly returning to the pre-1945 world. Compared to what we are used to, it will be much more dangerous, uncertain, risky and volatile. However, there still remains a huge disconnect between public expectations, which assume that governments can and should be responsible to provide and protect, and the reality that they can no longer do it. No politician is prepared to stand up and say that the “emperor has no clothes”. So where does gold fit in this brave new world?
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