The U.S. Senate passed a $1.1 trillion spending bill this Sunday, December 13th. Five other appropriation bills for fiscal year 2010 were previously passed earlier this year and one more still remains, a $626 billion defense appropriation. The defense appropriation bill will contain a clause to raise the national debt ceiling. The national debt ceiling is currently $12.1 trillion and the U.S. is tapped out once again. As of now, it looks like Congress will raise the debt ceiling by $1.8 trillion to $13.9 trillion. The last increase was only $0.8 trillion, but that would only last months at this point. Even with a $1.8 trillion increase, the U.S. Congress will be fortunate if it doesn't have to raise the ceiling again before 2010 runs out.
The increase in the U.S. national debt is now so great that the monthly rise can be as high as the entire debt load in the 1960s (before the U.S. went off the gold standard). The U.S. is also by no means unique. The spending spree taking place is global and includes all major economies. In the midst of this spending and money printing orgy, there are a number of economists who claim it will not hurt the U.S. dollar and will be a negative for gold. In order to come to this conclusion, they have had to ignore a greater than 2000 year history that indicates otherwise. The Romans engaged in long-term debasement of their coinage and paid for it with out of control inflation. Since then, the use of paper money has made currency debasement much easier and quicker. Nowadays, central banks can create any amount of currency they want through a simple computer entry. What they can't create out of thin air is actual money.
History is littered with fiat currencies (currencies not backed by hard assets) that have failed. There is no fiat currency that has survived over time. There is also no case of currency creation that significantly exceeds economic growth that hasn't led to inflation. This idea is by no means new. Copernicus the famous astronomer was one of the first to articulate it in the 1500s. It is based on simple arithmetic. If you double the amount of currency in circulation, but the economy doesn't change in size, goods and services will approximately double in price. This does not happen instantly, however. There is a delay from when a government increases money supply and when consumer prices rise. In the 1970s, money supply in the U.S. increased by the largest amount in 1971, inflation peaked 9 years later, as did the price of gold. So don't expect to see the full impact of today's monetary policy actions until late in the next decade.
Economist Nouriel Roubini has just released an article on why the price of gold will fall. It should be kept in mind that Professor Roubini is an economist and not a professional investor. Unlike myself and a number of other bloggers, he does not publish when he buys and sells assets, but tends to make broad sweeping generalized comments. This approach is rarely helpful to investors who are trying to make money in the market and usually works to accomplish the opposite. Let's look at Roubini's five reasons gold will fall and deal with them point by point:
Point 1: The U.S. dollar carry trade will unravel.
Indeed this will happen eventually. I heard similar arguments made about the Japanese yen carry trade unraveling for about 15 years. It was finally replaced by the U.S. dollar carry trade. So if you are are investing now based on how the world might look in the 2020s, pay attention to this point and just hope you don't go broke while waiting.
Point 2: Central banks will have to exit their quantitative easing strategies and jettison their effectively zero rate interest rate policies.
For governments to keep spending, they will have to continue to print money. National debts are now so huge that a significant increase in interest rates will cause the interest payments on the debt to skyrocket. Even assuming Credit Crisis bailouts and related economic damage no longer necessitate massive government budget deficits after a few more years, rising payments for government retirement and health programs will. There will be no respite. If unfunded liabilities for social security and medicaid are taking into account (which is required when using GAAP - generally accepted accounting principals), the U.S national debt is not $12 trillion, but somewhere between $60 trillion and $100 trillion. The official GDP is approximately $14 trillion.
As for interest rates, real interest rates are not zero, they are negative. Only highly massaged government statistics which understate the inflation rate make it look otherwise.
Point 3: Global risk aversion indicates that the U.S. dollar will rise and drive down the price of gold in dollar terms.
There are a number of problems with this assertion. First of all there are periods when both the U.S. dollar and gold rise, as happened at the end of the 1970s. Secondly, there is an implication that gold will be rising in non-dollar currencies (gold has been hitting new all-time highs in dollars, pounds, euros and Swiss francs lately). Thirdly, the statement essentially means that gold will not go straight up in price and the U.S. dollar will not go straight down, like every other major asset in history. So what else is new?
Point 4: The carry trade and the wall of liquidity from central banks is causing a global asset bubble and all bubbles eventually crash.
Indeed we are in the early stages of an asset bubble, with early being the operative word. People said the same things about stocks for years throughout the 1990s and eventually the bubble did peak. You, of course, make the most money by investing in bubbles. How can you tell when they are ending? This happens when there is a meteoric rise after many years of strong rallying. We know the history (or at least some of us do) of how the 1970s gold bubble ended. Gold went up 400% in the last year. Silver rose almost 1000%. Double digit annual price rises like we are currently witnessing are simply ordinary bull markets. While there may be a peak in gold prices in ten years, we are not anywhere near that point yet.
Point 5: The price of gold could be pushed up if there are expectations that central banks will monetize their countries' debts, but this increases investors risk aversion and will lead them to sell gold.
There is no way that most major economies can pay off their government debts. Monetizing them by creating inflation is the only alternative that will avoid default. One only needs to employ elementary school arithmetic to figure this out. The price of gold goes up with inflation. Yet Roubini contends the investor risk aversion will trump this factor. This could also be restated as theory will be more important than reality in the markets - the essence of all of Roubini's arguments in a nutshell. Investors and traders know better since they have to put real money on the line every day.
Roubini's current missive on gold prices is not a new view. Only a couple of months ago he made some highly negative comments on gold just as it started to rally 20%. He was wrong then, but being wrong in the economics profession has never damaged anyone's career. Roubini is not unique in his views, but is one of a group of economic alchemists who repeatedly tell the public that government can create more and more of a currency and this is going to lead to an increase in the currencies value (also stated as deflation). In other words, actual money and value can be created out of thin air and by implication there is a free lunch. Considering the amount of inflation that history tells us is about to take place, there had better be a free lunch because few people will be able to pay for the real one.
Disclosure: No positions