Gold's Current 'Message'

Judy Shelton has a good article about the virtues of a gold standard in yesterday's WSJ, so I thought I would add my chart (click to enlarge) on real gold prices to the discussion.

As this chart shows, real gold prices are not far from the highs they reached in the inflationary heydays of the early 1980s. As Judy notes in her article, when monetary policy is tied to a gold or commodity standard, inflation tends to be low. Allowing monetary policy to be guided by human discretion almost always leads to higher inflation.

Discretionary monetary policy in our recent past has undoubtedly contributed to volatile inflation, as well as real estate and commodity speculation. The rise in gold prices in both real and nominal terms since the early 2000s—right around the time that the Fed started easing in order to cushion the economy's decline during the 2001 recession—has now reached levels that are undeniably worrisome, since they are a clear sign of rising inflationary pressures.

As Judy explains, and as I've discussed before, easy money and rising inflation sap an economy's strength by diverting resources away from productive activities and towards speculative activities. We see living proof every day of the destructive impact of the housing price bubble, in which speculative demand for housing, fueled by cheap money, drove prices to unsustainable levels and resulted in excessive housing construction, only to be followed by a major collapse. We've also witnessed extreme volatility in energy and commodity prices this past year that have wreaked havoc among emerging economies around the world.

If I were Obama's advisor, I would be telling him that $1000 gold is a lot more troubling than the current recession. I would give him a copy of P.J. O'Rourke's article that channels Adam Smith on the solution for our housing crisis (clue: just let prices fall).

Smith told us long ago that housing can never be a source of wealth for an economy, regardless of whether housing prices rise or fall. The problem comes from over-building, which is inevitably followed by a construction bust and the need to redistribute the economy's energies. Housing construction collapsed long ago, and prices are rapidly returning to more reasonable levels, so what remains of this bursting bubble is more akin to a tempest in a teapot than a threat to modern civilization as we know it.

Late last month I highlighted a significant new trend in the TIPS market, in which investors' expectations of deflation were rapidly fading. The next chapter in this story could be how yesterday's fading deflation fears are gradually replaced by tomorrow's rising inflation fears. We're on a monetary roller coaster, folks.

The world seems to be ignoring inflation risk these days, out of concerns that collapsing housing and commodity markets, coupled with a significant decline in economic activity, will keep central banks' desperate attempts to boost money supply from igniting inflation. The message of gold is that these concerns could be wildly misplaced. This is a message that applies to all investors around the world, because all major currencies today are rapidly losing value against gold, the traditional standard of value.

I still believe the U.S. economy will recover from this recession sooner than most people think, but as I've said before, the recovery is likely to be be sub-par for quite some time. The economy will be bogged down for years by rising inflation pressures—which will probably show up in another asset price bubble somewhere—and by a significant expansion of government influence in the economy, thanks to the hugely bloated faux-stimulus bill that will probably be passed this week.

I must add that it was refreshing to see the news just a short while ago that Judd Gregg was withdrawing his name from the nomination to the Commerce Secretary post. It would appear that there are still some men of principle in Washington. And it's one more sign that Obama could really use some better advice when it comes to economic policy.

Full disclosure: I am long TIP at the time of this writing.

Comments

[ROLEX18:]

Gold is up, but long investors lost all the money in Gold stocks.

Feb 13 07:06 AM

[yellowhoard:]

Let there be no doubt, Obama was not looking for sound economic advice when he selected Gregg for Commerce Sec. Obama merely wanted the veneer of moderation in his cabinet. By making clear that Rom E. was going to cook the census, the administration dissed Gregg before he was even confirmed.

My guess is the Obama team realized they did not need to strip away a GOP senate seat to pass their package when Collins, Snow and Specter crossed the aisle.

Obama is not a consensus builder. At Harvard Law there were no conservatives. In Chicago there were no conservatives. In the Illinois senate, he voted present. In the US senate, he was the most liberal seat in the chamber. Why would anyone think that he has a penchant for bi partisanship?

The Dems are not interested in recovery or infrastructure. They are burying their roots so deeply that we won't be able to tear them out of office no matter how bad the economy is. Watch for 10 million new voters through amnesty. Watch for felons being given the right to vote. Watch for Acorn to get massive funding for more voter fraud.

This has been a velvet coup. We will never have a viable two party system again.

Feb 13 08:57 AM

[know nothing:]

The stock market is like your favorite jeans or favorite pair of shoes, you love them so much that you wear them out. Even after they are wore out you wear them some more,they become like a old friend, that you just don't want to lose, or throw away. But one day they must go, they have been used up!

The stock market is following the same path, many people expanded their balance sheets by investing in the stock market, they secured their retirement saving,(or so they thought) secured their future. They have lived through many market corrections, which have always reversed themselfs, leading to more gains in the future. The stock market has become a old friend to many..

But now comes a time for change. The previous gains made in the stock market, may take decades or longer to duplicate. The unregulated financials, coupled with unregulated stock market, and politicians gone wild over the last 10 years, has leed to corruption, scams and unprecidented greed. The greedy banksters,wall street brokers, and politicians, have used up the system, they wore it out! These last couple of last ditch efforts, (printing money, finicial bailouts... ect) are a desprate attempt to try and salvage whats left of the ragged system they once loved and depended on.

But now our system is just like the favorite pair of jeans or shoes, it's wore out and needs to be thrown out. It's been used and abused to the bitter end. While waiting for a new system to be born, many will desperately try are use the stock market to regain what has been lost of thier wealth Others will go to safe havens, to try and preserve anything they have left.

Where do we go from here? The answer to that question may very well be a generation away. Only time will tell. In the mean time, Gold and silver are much safer to hold your wealth in while you wait for the answer.

Feb 13 09:13 AM

[kelm:]

Good article.

Gold is moving on rising inflation expectations and a growing concern with paper currencies due to the profligate fiscal policies of many of the worlds governments and especially our own. That is a factor that was not present in the previous run-ups. An ECB spokesman yesterday publicly stated their rising concern that the printing press culture of monetary expansion was raising distrust in paper currencies world wide. Watch the nuanced comments from Chinese officials lately regarding treasuries and the dollar. They are trying to tactfully tell us they are becoming alarmed with our policies.

As I've written to my readers I really hate the idea that fiat currencies can't be made to work. Holding something physical seems so...medieval. Why not colored glass beads or nice pretty sea shells? But the fact is we are debasing our paper currencies to a level that will cause a violent swing to precious metals. I am not a gold "bug" I am a realist.

Disclosures: long CEF, TGLDX, TBT, PST, UDN

Feb 13 10:22 AM

[Carlos Lam:]

Of course, gold is trying to send the message that a general increase in prices is coming in the near future. Consumer prices are going to ratchet up because the dollar is being printed to death; the "value" of each individual dollar is being diluted by the raft of new greenbacks being created. Such dilution can result in only one result: it will take more individual dollars to buy any given commodity (i.e. gold, petroleum, food). Perhaps only real estate will continue to fall; home prices are still way too high.

I shudder at the thought that the "greatest brains" in America (Bernanke, Geithner, Summers) think that we can print and spend our way to prosperity. Force-feeding debt to overburdened consumers is the LAST thing America needs. Instead of giving tax breaks for home and car buying, why not allow Americans to repay household debt with pretax money, thereby creating a tax incentive for us to clear up our balance sheets?

Gold is still under $1,000 per ounce; stocking up now is not a bad idea. Using the Dow/gold ratio as a guide, gold still has a long way to go up if the Dow ends up bottoming out at 5000, as Bill Bonner argues (Bonner's number is the lowest I've been able to find). In 1932, the Dow/gold ration hit 2:1 at the market bottom. In 1980, it hit 1:1 before the bottom. Before all is said and done, I wouldn't be surprised if gold went to $2,000 before a turnaround. Then again, trying to predict the market using historical data is fraught with peril!

Feb 13 10:32 AM

[Carlos Lam:]

On Feb 13 10:22 AM kelm wrote:

> As I've written to my readers I really hate the idea that fiat currencies
> can't be made to work.

Why would you "hate" the idea that fiat paper doesn't work? Fiat currencies are created and managed by governments who are inhabited by men with their own agendas. By definition, then, a fiat currency places a people at the mercy of those in power. Moreover, the US did not have a fiat currency for a great portion of its existence, and the economic growth experienced in 19th century America was astounding. The philosophical and historical evidence, it can be argued, militates against the adoption and use of fiat currencies.

Feb 13 10:35 AM

[iyamwutiam:]

There were some numbers floating around that said that global stimulus is about 3% of global GDP. Which is ludicrous since -if Global GDP is around 50trillion -that means the US itself has put up all of the stimulus. I would say more like 8% of GDP - when you throw in the Euro countries (England for sure), China and the rest of the world. In short- massive global fiat money creation will lead to inflation - and most investors see the writing on the wall.

All of a sudden you now find an increasing number of articles propounding shorting Gold. Which basically means -that there are a lot of concerned policy people that private investor dollars will see commodities as a safer haven than government bonds/ corporate bonds. Which means that the stimulus will have to continue till atleast 2010 if not 2011.

There will be a concerted effort to drive investors back into bonds and equities -so look for some funny action in commodities. Which will take off -once all this stimulus comes on board.

Feb 13 12:07 PM

[Rob Viglione:]

My portfolio is very long gold for the same reasons presented in this article and commentary, but I'm still opening small positions in GLD puts as a hedge. With so much emotion on both sides of the gold-inflation argument, it pays to do a little hedging just in case your side doesn't win.

Feb 13 01:14 PM

[Queen Isabelle:]

Dear Calafia,

Nice analysis, but to the first step in achieving sound monetary policy and economic stability, is to shut down and audit the Fed. The next positive action would be to arrest Bernanke and Greenspan for high treason.

Viva Christo Rey!
Isabelle

Feb 13 01:35 PM

[Socialism c...:]

Instead of all this overly complex taxation and your notion of paying debt pre-tax...we need to wake up to the fact that the government should NOT HAVE a preemptive right to our earnings. Confiscatory taxation was anathema to the Founders!!! And it should be to us. We need to move to the Fair Tax, or something similar -- sales tax-based. That gets us to your notion of allowing us to pay down our debts pre-tax, but goes further as well -- allowing us to keep ALL of our own money until we decided to spend it. The IRS must be ended in order to restore sane government.


On Feb 13 10:32 AM clam75 wrote:

> Of course, gold is trying to send the message that a general increase
> in prices is coming in the near future. Consumer prices are going
> to ratchet up because the dollar is being printed to death; the "value"
> of each individual dollar is being diluted by the raft of new greenbacks
> being created. Such dilution can result in only one result: it will
> take more individual dollars to buy any given commodity (i.e. gold,
> petroleum, food). Perhaps only real estate will continue to fall;
> home prices are still way too high.
>
> I shudder at the thought that the "greatest brains" in America (Bernanke,
> Geithner, Summers) think that we can print and spend our way to prosperity.
> Force-feeding debt to overburdened consumers is the LAST thing America
> needs. Instead of giving tax breaks for home and car buying, why
> not allow Americans to repay household debt with pretax money, thereby
> creating a tax incentive for us to clear up our balance sheets?<br/>
>
> Gold is still under $1,000 per ounce; stocking up now is not a bad
> idea. Using the Dow/gold ratio as a guide, gold still has a long
> way to go up if the Dow ends up bottoming out at 5000, as Bill Bonner
> argues (Bonner's number is the lowest I've been able to find). In
> 1932, the Dow/gold ration hit 2:1 at the market bottom. In 1980,
> it hit 1:1 before the bottom. Before all is said and done, I wouldn't
> be surprised if gold went to $2,000 before a turnaround. Then again,
> trying to predict the market using historical data is fraught with
> peril!

Feb 13 01:39 PM

[Socialism c...:]

Viva! De los siglos y por los siglos!!


On Feb 13 01:35 PM Queen Isabelle wrote:

> Dear Calafia,
>
> Nice analysis, but to the first step in achieving sound monetary
> policy and economic stability, is to shut down and audit the Fed.
> The next positive action would be to arrest Bernanke and Greenspan
> for high treason.
>
> Viva Christo Rey!
> Isabelle

Feb 13 01:40 PM

[Socialism c...:]

You know who the real "realists" were? Our Founders. Here's what some of them and some of the great men in our nation's past said about currency manipulation:

* "I sincerely believe ... that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale." – Thomas Jefferson

* "Of all the contrivances for cheating the laboring classes of mankind, none has been more effective than that which deludes them with paper money." – Daniel Webster

* "Whoever controls the volume of money in any country is absolute master of all industry and commerce." – James A. Garfield

* "All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation." – John Adams



On Feb 13 10:22 AM kelm wrote:

> As I've written to my readers I really hate the idea that fiat currencies
> can't be made to work. Holding something physical seems so...medieval.
> Why not colored glass beads or nice pretty sea shells? But the fact
> is we are debasing our paper currencies to a level that will cause
> a violent swing to precious metals. I am not a gold "bug" I am a
> realist.

Feb 13 01:42 PM

[CitizenPete:]

I would like to believe that gold is telling us: "Hey look at me, I'm real money, not that fractional reserve credit that has been run out to nothing". But of course in a Keynesian dominated economic society it would be awfully difficult for bankers and politicians to relinquish their exclusive power to generate unrestricted paper and digital credit. The fact is that is if you actually printed the quadrillion(s) of fraudulent fiat credit circulating the globe, the physical paper weight would vastly outweigh all the gold and silver available on the planet.
Facts are facts. Gold and Silver are lawful money according to the laws of the Republic of the United States of America. Fractional Reserve Banking was tacked later as law by the banks, but the original gold and silver laws still exist last time I checked. For anyone romantic about gold and silver, a YouTuber created a pretty concise two part video on the history of money in the US. It's basic, short and sweet and IMHO he did a good job with it. Part one (8 minutes long) can be found here: www.youtube.com/watch?...

Feb 13 11:19 PM

[ronslim:]

I am long gold. That said the other side has some interesting questions.

1. Rule change mark to market gone, balance sheets magically repaired

2. CDS intervention and transparency returns

3. bad assets returned to banks with "new value" government debt goes down, dollar rally

4. house buying incentives added, zero down etc. "because this is no time to act fiscally prudent" The sheeple buy it and gleefully charge up their accounts

5. Obama and the dems claim victory for the success of
the liberty confiscation act and demonize the repubs for standing against it



6. Obama demands and gets elected for life.

Q. what happens to gold then?

Feb 14 11:49 AM