February 17, 2004

Bernstein: Use Gold to Hedge against Possible Crisis

NEW YORK (HedgeWorld.com)-Distinguished author and economic consultant Peter Bernstein advocates hedging against a potential scenario of growing malaise in the U.S. economy.

Speaking to a ballroom full of school endowment executives at a National Association of College and University Business Officers conference, Mr. Bernstein analyzed approximately 30 years of economic history, from the free market policies of Ronald Reagan and Margaret Thatcher to last month's declines in the U.S. dollar.

He sees a recent economic shift that has brought on a loss of American jobs to other parts of the world, declining labor compensation and a growing federal budget deficit. On this basis, he suggested to endowment officers that their best bet currently is to take a core equity portfolio and put a defensive rim around it of gold and foreign currency.

While alternative investments have been good and very useful, they do not serve this defensive purpose, he said, arguing that hedge funds and other alternatives work well in a conventional environment but won't give investors the big upside they will need in the case of extreme events.

Worst-Case Scenario

Mr. Bernstein focused in particular on the phenomenon of dis-inflation that started in the Reagan and Thatcher years. This lid on prices means that lowest-cost providers across the globe win out and that nobody has pricing power under intense worldwide competition.

While it solved the previous problems of economic rigidity, making possible a blossoming of technological innovation and growth, this development now is creating its own problems, Mr. Bernstein said.

As he sees it, Asian economies are gaining while the United States is losing jobs. Moreover, Asian populations are saving and lending to Americans, who need to borrow to finance excess spending. Mr. Bernstein questioned the long-term viability of the "we buy and they finance" arrangement and identified the growing federal budget deficit as a major reason for international imbalance.

Another concern is the continuing growth of income inequality in the United States. The recent increase in profitability comes at the expense of workers, with the share of employee compensation falling, Mr. Bernstein said, claiming that people are forced to hunt for bargains and that is what makes Wal-Mart an icon of the American economy.

His worst-case scenario involves growing unemployment and a dollar crisis. Acknowledging that such dire warnings in the past typically have not come to pass, he advised holding stocks in case this forecast is wrong but at the same time preparing for the worst.

Think of the non-equity side of your portfolio as a hedge, not a volatility reducer, he recommended. Because hedging is expensive, he advocates using instruments such as gold that would provide the greatest upside if economic imbalances generate shocks. "The hedge should give you the biggest bang for the buck if I am right," he said.

CKurdas@HedgeWorld.com

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