All-ahead Full for Gold

By Scott Silva

Editor,  The Gold Speculator

5-23-11

Gold is riding high now and its price will move higher as more economic data confirms the US economy will remain sluggish for the foreseeable future. Gold regained the $1500/oz level since dropping from its all-time high of $1577.40 on May 2^nd.  The week-long sell-off in gold early this month was modest compared to price drops of other commodities. But gold did not experience the parabolic rise of silver, oil, wheat and some other commodities over the last six months.  Instead, gold has seen a steady rise in price, a long bull move dating back to January 2001.

What is propelling gold higher?  A big part of the answer is government intervention in the financial markets and the stubbornness of monetarists who cling to the false notion that as “Masters of the Universe”, they indeed can control economies at the local, national and global levels. Like the forlorn bond trader Sherman McCoy in Tom Wolf’s Bonfire of the Vanities,  Ben Bernanke is coming to realize his “sure thing” is in a reality a colossal cropper.

The economy is not responding to any form of stimulus—not the $835 Billion stimulus package; not near-zero Fed fund rates; not Quantitative Easing 1; not Quantitative Easing 2. By every measure, Washington economic policymakers have failed.

Some say that the emergency actions of the Fed and US Treasury averted a steep depression in 2009. We will never know for sure. What we know from history is free markets recover more quickly from depressions than economies that are “managed” by central planners.  The depression of 1920 lasted only two years because President Harding’s hands off monetary policy allowed for natural recovery. The Great Depression lasted eleven years, largely because of FDR’s stimulus spending programs and Fed’s mismanagement of the money supply.

In the current case, bank bailouts and the subsequent easy money policies have created some terrible unintended consequences. Excess liquidity in the system has caused a rapid rise in commodity prices, which is causing inflation at the producer and consumer levels. The US Dollar is losing value compared to other currencies and is losing purchasing power. Demand is weak so, despite low interest rates, businesses are not expanding and unemployment is high.

The numbers tell the story: GDP growth 1.8%; Unemployment 9.0%; Core Inflation 2.1% (actual inflation 6-10%);  2011 Deficit $1.6 Trillion; US Debt $14.3 Trillion.

Something has to change. At his press conference last month, Chairman Bernanke announced he is ending Quantitative Easing 2 on schedule at the end of June. This would be quite a change. But the gold market has said no to the Chairman’s pronouncement. Gold has climbed in price, signaling there will be something like QE3 in late June. At the least, QE3 (sotto voce) will be continued Fed buying and expansion of its balance sheet through reinvestment of proceeds from maturing issues.  A more formal QE3 may also be in the offing.

But here’s the rub. Chairman Ben, like Homer’s Odysseus, attempting to navigate the Strait of Messina, must avoid Scylla to port and Charybdis to starboard.  Continued easing will accelerate inflation, devalue the Dollar and inhibit business growth (low capital costs favor consolidation rather than organic growth).  Any reduction of Fed assets will raise interest rates and slow whatever recovery is underway, which might cause a double-dip recession. Tightening will also impact interest rates on US Debt. All are bad outcomes for the economy.

The Chairman is facing dissent to continued easy money policy by members of the Fed. Last week, Thomas Hoenig, long-serving president of the Federal Reserve Bank of Kansas City, publically challenged the accommodative policies that the central bank has pursued since 2009. While many of the Fed’s Board of Governors and members of the Federal Open Market Committee view near-zero interest rates and massive infusions of cash into the economy as the best path to economic recovery, Hoenig believes the policies are “…sowing the seeds of the next financial crisis. When you put this much money into the economy, it's got to deploy. Some of it is deployed into commodity assets. You're going to have volatility in that environment, and we are seeing volatility.”

“The inflation of the 1980s started in the mid-'60s. It is a slow process along the way, but if you leave policy easy, then inflation will eventually catch hold.

This inflation we're seeing is in everything now. It's not just in gas. Companies are telling me, ‘We're seeing 20 percent price increases in our inputs and passing along 10 percent or more.’ We're starting to see the psychology of inflation slowly change.”

If it were up to Hoenig, the Fed would cut the easy money era short, right now. He is not alone. Narayana Kocherlakota, president of the Minneapolis Fed, has voiced concern that excess bank reserves may create much higher inflation than we are seeing now. Today, Fed banks are holding $1.6 Trillion in excess reserves. Kocherlakota advocates selling $15 billion-25 billion of MBS a month, which would restore Fed balance sheet assets to more traditional levels in five years instead of the 30 it would take for the bonds to mature.

Maybe the Fed and others in Washington will come to realize that the best course of action for the Fed is to take their hands of the wheel and feet off the pedals. They’re not connected anyway. Only free markets determine what is to be.

Time will tell. In the meantime, gold is telling us that prudent investors are hedging their bets that the US economy will turn up sharply anytime soon.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055