One of our readers—Gary L.—wrote to ask:
“Al, the dollar index is at 83, and gold is at 1575. The Fed. has printed money, or so the broadcasts say, so shouldn’t we be seeing inflation and a devalued dollar?
“Two years ago the index was at 72. Obama and Bernanke proclaim quantitative easing and buy up government debt so Congress can spend money as drunken sailors, and whamo, the dollar increases its value.
“My dollars are increasing in value while my gold is sinking.
“Help! What is going on? Aren’t we just like The Weimar republic, or so I was told. What is going on?!”
Short answer: I don’t know.
Medium answer: We live in interesting (some say “crazy”) times. I’m as mystified as you are.
1. EU Crisis. Conventional wisdom generally agrees that this year’s financial and political crises in the EU caused anxious Europeans to flee the euro and run to fiat dollars. As a result of billions of euros being traded for dollars, the value of the dollar (as measured on the US Dollar Index) has been artificially increased. As the dollar rose, the prices for commodities like gold, silver and crude oil declined.
If Europeans had sought refuge primarily in gold, the price of gold would’ve risen and the value of the dollar would’ve fallen. However, Europeans sought the “safety” of paper dollars, so the dollar’s up and gold is down.
Why Europeans sought the “safety” of paper dollars rather than gold is beyond me. It’s equivalent to running from the bow of the Titanic to the stern. It reflects the short-term view of speculators, rather than the long-term view of investors. You might buy a little time, but you are still doomed.
We can assume that if the EU crisis moderates or even ends, the flight to paper dollars will also end, the value of the dollar will fall, and the price of gold should rise.
If the EU suffers a real crack-up, God only knows what the short term effect on gold and dollars might be. Both could rise dramatically. Or, perhaps the dollar would rise and gold would (temporarily) fall. Or, maybe gold would rise and the dollar would fall. In the midst of chaos, who can say?
But, even after chaos, the markets should settle down within six months or so, the long term trend of depreciating dollars and rising gold prices should reassert itself, and we should see the dollar fall and gold rise.
2. Market Manipulation. The Gold Anti-Trust Action committee (GATA) has alleged for most of a decade that the Powers That Be (PTB) manipulate the gold and silver commodities markets to suppress the prices of those monetary metals.
Some people dismiss the claims of manipulation as wild-eyed “conspiracy theories”.
However, the recent Libor/Barclay’s scandal has proved that global interest rates have been manipulated. Barclays admitted to participating in such manipulation and has accepted a $480 million fine.
If the PTB can manipulate global interest rates, they can surely manipulate the gold and silver commodities markets. Perhaps the seemingly inexplicable fall in the price of gold and rise in the value of the fiat dollar are due—at least in part—to market manipulation.
3. Election Correction? (a subset of “Market Manipulation”)
The last time we had a major correction in the price of gold was A.D. 2008. A.D. 2008 and A.D. 2012 have this in common: they’re both presidential election years.
There appears to be an association between the prices of gold and crude oil. Generally speaking, when the price of crude goes up, so does gold. When the price of gold goes down, so does crude.
Whenever the price of crude increases, the prices of gasoline, diesel fuel and fertilizer also rise. When the prices of gas, diesel and fertilizer rise, so does the price of food. When the prices of gas and food are rising, consumers (read “voters”) know it and become fearful or angry. Fearful and/or angry voters tend to vote against incumbent politicians.
Thus, in a presidential election year, if the price of gold could be suppressed, and if the price of crude oil followed downward, then the prices of gas and food would also fall, voters would tend to be happy, and incumbents would tend to be reelected.
If A.D. 2012 is just another “Election Correction” of the sort seen in A.D. 2008, we can expect the prices of gold, silver and crude oil to be suppressed until after the November election. Then—in November or December of this year, or perhaps first quarter of next year—the prices of gold, silver and crude should increase dramatically and continue to do so for the next three years (until the next presidential election in A.D. 2016).
4. Insufficient Inflation. As Gary pointed out in his question, the government and Federal Reserve have injected trillions of paper dollars into the economy. Those trillions of dollars were intended to offset the growing forces of recession, depression and monetary deflation. However, the inflationary effects of all that extra paper currency have not, so far, caused significant inflation, “stimulus” and a corresponding increases the price of gold.
It’s possible that the government and Fed have underestimated the free market forces of deflation, and have therefore failed (so far) to inject enough currency into the economy to cause significant inflation.
Thus, perhaps the rising value of the dollar and the falling price of gold reflect the government’s and Federal Reserve’s failure to “fully inflate” the currency.
I doubt that this explanation is true. If it is true, I doubt that it’s the predominate cause for the price and value anomalies of which Gary complained. But it could be a partial explanation.
5. Public Anxiety? In the aftermath of the A.D. 2008 “collapse,” Americans became so anxious about their economic future that their savings rate jumped from 0.4% of their income in A.D. 2007to 6.9% in A.D. 2009. At least part of America’s renewed appetite for savings was directed towards saving their wealth in the form of gold. Result? Increased demand for gold contributed to the rise in the price of gold.
However, early this year, Americans started spending more and saving less, and our average savings rate declined to 3.5%. Reduced savings may have translated into a reduced demand (and price) for gold.
Today, rising unemployment may have reached a level where Americans are no longer capable of spending or even saving in terms of paper dollars or gold.
If so, the demand for gold might be falling and the price should follow.
However, this possibility makes little sense to me since central banks and governments around the world have continued to purchase tons of gold throughout this year. I assume that the purchases of tons of gold by institutions will largely compensate for any decline in the public purchases of gold.
Still, it’s conceivable that the American people are so financially stressed that they’re no longer capable of saving in terms of dollars or in terms of gold. The people might’ve “hit the wall”.
If so, we may be teetering on the edge of a legitimate economic collapse that could start to snowball at any moment.
I.e., in our “consumer” economy, 70% of our GDP has been based on “consumers” buying “stuff”. If “consumers” are so broke they can’t save, so broke they can’t borrow, and so broke that they’re afraid to spend a nickel if they don’t have to—can the “consumer” economy survive?
The loss of some significant number of “consumers” may not merely cause the “consumer economy” to suffer a proportional decline. It’s possible that the decline in consumers could reach a point where the “consumer economy” model is no longer viable. At that point a new economic—and possibly new political—model might be required.
I doubt that we can change economic or political “models” without suffering chaos and perhaps even a shooting revolution.
I don’t believe that consumers are, in general, so broke that they can’t or won’t spend or even save. But it’s possible. If it’s true, we’re in trouble.
(If the national economy were in a lot of trouble, would you rather have a pocketful of paper dollars or a pocketful of gold coins?)
6. Public Complacency? It’s possible that, after several months of falling gas prices and food prices that are falling or at least fairly stable (see, # 3, supra, “Election Correction?”), that the public thinks the economy is “stable”. Not good, but not getting any worse–and therefore survivable.
So long as the dollar is deflating and rising in purchasing power, the people are enjoying a “raise”. Maybe their boss hasn’t given them a raise, but even with the same salary, they can buy more today with $100 than they could a year ago.
We haven’t suffered a real economic shock since A.D. 2008. Therefore, for some, the world may seem to be a more stable and less hostile place today than it was a year ago. No one is euphoric, but many may have become complacent.
Gold is a hedge against economic and political instability, turmoil and change. Complacent people don’t see any turmoil coming and therefore don’t buy gold.
I regard such complacency as foolish. Those American who think our economic problems have stabilized are, to me, like people who’ve gone through the hurricane and think the storm is over—but don’t realize they are merely in the pacific “eye” of the hurricane. I believe there’s more trouble coming and probably greater trouble than we’ve already seen.
I am not complacent. I see myself as an objectivist rather than a pessimist, but I believe the worst is yet to come.
But many, perhaps most, people will disagree with me. Such people would be complacent and therefore disinterested in buying gold. If so, private demand is down and that should contribute to falling prices.
I suspect that “complacency” may explain 10% to 20% of the fall in gold’s price. Of course, if we suffer another economic shock, that complacency should vanish and the demand/price for gold should jump.
Any or all of the previous possibilities could explain (at least temporarily) part or all of the current rise in the value of paper dollars and fall in the price of gold.
In his questions at the beginning of this article, Gary presented some facts that are confusing and bewildering. The value of the fiat dollar is rising. The price of gold is falling. In a rational world, these phenomena can seem incomprehensible and even scary. The world has seemingly gone mad.
For me, these fantastic monetary phenomena are somewhat like watching a TV magician. Presto-changeo! The woman in the cage turns into a tiger. I’m impressed. I’m amazed. I don’t know how that guy with the cape did it . . . but I don’t believe it was supernatural magic. I know it was a trick.
The same is true with this year’s irrational (“supernatural”) rise in the value of the dollar and fall in the price of gold. I may not understand it, but I know it’s not magical. It’s some sort of trick.
Faced with a “trick” I don’t understand, I look back at what I believe are the “fundamentals” that I do understand. Those fundamentals are:
1. The US government is the world’s biggest debtor.
2. The US government loves inflation because it allows the government to repay its debts with “cheaper dollars”. Because of government’s great love for inflation, the paper dollar has lost 95% of its former purchasing power to inflation in just my lifetime. This persistent loss is absolute evidence that it’s been government policy to cause inflation for over half a century. I do not believe that the government’s love of inflation has died. I conclude that so long as government has power to inflate the currency, it will do so—and the price of gold must therefore rise. There may be episodes of deflation (as in A.D. 2008 and 2012), but they are temporary.
3. The US government hates deflation because it causes government to repay its debts with “more expensive” dollars. So long as the dollar is growing in value, so is the real size (the purchasing power) of the national debt. Government does not want the real size of the national debt to grow. Therefore, they must hate the rising purchasing power of the dollar (and correlative fall in the price of gold) that we’ve seen for the past 9 months.
Perhaps the government has intentionally caused the rise in the purchasing power of the dollar to help reelect Obama and other incumbent politicians. Perhaps the EU crisis is too great for the US government to resist and therefore the US will endure deflation while it must—but will shift back to inflation as soon as it can.
My bet is that no later than December, the dollar perceived value should stop rising and the price of gold should jump.
4. The free market will rise again. If the gold and silver markets have been manipulated to suppress their prices, we don’t have “free” markets—we have “manipulated” or “un-free” markets.
However, as the Libor/Barclays Bank scandal proves, the costs of market manipulation can’t be sustained indefinitely. Sooner or later, the scam will collapse, manipulated markets will be confessed, and the free market will reassert itself.
I believe the price of gold has been intentionally suppressed by market manipulation. If that’s true, it follows that once the free market is restored, today’s “suppressed” price of gold will quickly rise to its true, free market price.
What is the true, free market price of gold? No one knows. Some say $3,000. Some, $5,000. A few, $25,000. But if the price of gold is being artificially suppressed today, sooner or later, gold will jump dramatically to its true, free-market price.
5. Governments always devolve into criminal enterprises. Governments always, ultimately, rob their creditors. This isn’t news. As I reported last week in “The Wealth of Nations vs. the Debts of Governments,” Adam Smith (the author of The Wealth of Nations published in A.D. 1776) reported that governments have routinely and repeatedly robbed their creditors by devaluing (inflating) their currencies for over 2,000 years. It’s what governments do.
Therefore, anyone holding a paper debt-instrument (like a fiat dollar, a bank book, a stock, bond or pension fund) denominated in dollars will lose some or all of his wealth. Government never once intended to repay all of its debts in full. The only question is how much will government steal from its current creditors: 3%? 20%? 90%?
6. The total national debt is too great to be repaid in full. The feds say the national debt is $16 trillion—John Williams at Shadowstats.com says that debt is $80 trillion. I believe Williams.
If Williams is right, at least 50% of the existing national debt must be repudiated. I predict the government will ultimately repudiate 90% of that debt. Depending on the real size of the national debt, the price of gold should increase by 200% to 900% in the foreseeable future.
6. The bull market in gold has been running for 11 years. There’s no compelling reason to believe that it’s over.
7. According to the Erste Group: “Negative interest rates constitute a perfect environment for the gold price. During the 20 years of the gold bear market in the 1980s and 1990s, the average real interest rate level was around +4%. Since 2000, real interest rates have been negative for 51% of the time, which constitutes an optimal environment for gold. The fact that the Federal Reserve will now maintain its zero-interest policy until 2014 should result in prolonged negative real interest rates and thus create a positive foundation for further increases in the gold price.”
Federal Reserve chairman Ben Bernanke announced just yesterday that near-zero interest rates will continue at least to the end of A.D. 2014. This trend of near zero interest rates is likely to continue beyond A.D. 2014 and therefore the price of gold is likely to increase.
8. If the Good LORD is willing, I expect to live long enough to see the value of paper dollars fall to zero. If I don’t live that long, some of you will.
But none of us, none of our children, none of our grandchildren will ever live long enough to see the price or value of gold fall to zero. It will never happen in this life.
In relation to short-term speculation (weeks or even months), it might be better to hold dollars right now rather than gold. But the speculative profits associated with fiat dollars could end at any moment. If there’s a short-term significant profit in paper dollars, there’s also a short-term potential risk of significant loss.
In terms of long-term investments (a year or more), you’d have to be crazy to want paper dollars rather than gold. Nothing’s impossible, but does anyone seriously believe that the price and value of gold will be lower one year from now than it is today? Does anyone seriously believe that the dollar will be even more valuable next year than it is today?
I don’t know when the dollar’s value will hit zero, but it’ll happen in the next decade, it could happen in the next three years—remotely, it might happen in the next twelve months.
When the dollar zeroes out, some people will hang onto their fiat dollars in hopes that they’ll once again become valuable—just as people in the South continued to hold onto their confederate dollars after the Civil War.
Others will be holding gold.
Which would you rather be?
• We’re in a period of confusion. The dollar’s up; gold is down—and without reason that anyone has clearly understood and articulated.
So what do you do in a period of uncertainty? You go back to fundamentals and act accordingly.
For me, the fundamentals say gold must go higher. Maybe not this month. Maybe not his quarter. But soon.
Therefore, I’m not going to panic. I’m going to ignore the confusion, trust in the fundamentals and hang on to my gold until the market begins to act in ways I find reasonable.
I suggest you do the same.