Thursday, March 24, 2011

The folly of thinking the future can be predicted

During his budget speech on March 23rd UK Chancellor of the Exchequer, George Osborne, had the following to say:

"We have already decided to rebuild our foreign currency reserves, and we intend to purchase a range of high quality assets. But with the price of gold at a record high we won't be able to replenish the reserves sold at a record low."

The “record low” comment was a reference to the fact that, between 1999 and 2002, the UK treasury divested itself of just under 400 metric tonnes of gold from its reserves. The average price achieved was $275.00 per (troy) ounce. 400 tonnes converts to 12.86 million ounces so the proceeds of the sale amounted to $3.5 Billion. On the day of the 2011 budget the spot price of gold was $1,438.00 per ounce. At that level the UK reserves sold off nine or so years ago would have realised just under $18.5 Billion, representing a capital gain foregone of some $15 Billion or 9.225 Billion pounds sterling because of the sale. The Chancellor at the time of the disposal was one Mr. Gordon Brown, of the New Labour persuasion, and therefore someone who could predictably be subjected to a jibe by a Tory minister, in hindsight of course, for the decision.

The fact of the matter is that the UK treasury, under Mr. Brown, honestly believed it had good reasons at the time for selling the gold. These included a need to minimise fiscal risk by diversifying into currency assets such as Euros, US Dollars and Yen, which are interest bearing while gold is not, an acceptance by all parties that gold was more volatile than the currencies mentioned (volatility is a proxy for risk) and a perception that gold was then overvalued. So strong was the last belief that many gold producing nations objected strongly to the proposed sale on the ground that the price of gold would be depressed.

However, even given the above, there is little doubt but that if Mr. Brown and his advisors had possessed the slightest inkling of what was about to happen to the gold price they would, most certainly, have postponed the sale or abandoned the idea altogether.

In the middle of 2010, not quite a year ago, the UK Centre for Economic and Business Research (CEBR) predicted that the “Euro Will Fall to Parity [with the US Dollar] Before ‘Inevitable’ Breakup”. During the course of the analysis they qualified the break-up prediction by saying that it could take as many as ten years. However, at year end, they were still at it, claiming the rapid decline of the Euro as the first on their list of predictions for 2011. Once again, parity with the US dollar was the target level. At the time of writing, some three months into 2011, the Euro is going from strength to strength. The reason for this is the determination of the European Central Bank (ECB) to ensure that the Common Currency is a success. It now appears that the advice of economists over the years to the effect that “you do not fight the Fed”, meaning the Federal Reserve System of the USA, effectively the US Central Bank, can just as easily be applied to its European counterpart.
In the Irish Times of March 25th 2011 our own Minister for Finance, Michael Noonan, was quoted as saying:
"No matter how wise one is, it is not possible to say the debt will be unsustainable next week, next month, next year or in three years’ time".
How right he is.
What all these examples mean, of course, is that it is impossible to predict the future. Not even if you’re a prominent and well experienced grouping of economists, or if you have at your disposal all the resources of the UK government, which are substantial indeed. That’s the fundamental truth that must be reflected upon.

All one can do in light of all this is to minimise risk and that, of course, can only be done with the information available at the time it is decided to act. The very decision to act, or not, must be seen as part of the process. If the outcome is still a loss or a disappointment then the only thing left is hindsight and no matter how tempting it is for critics to indulge in this, it is, at the end of the day, an irrational and fundamentally unhelpful impulse.

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