On Central Banks and Gold's New High

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Includes: DIA, GLD, IAU, SPY
by: Myron Shlapak

Gold has had quite a run over the past few years and has recently broken its all-time highs. At least highs priced in current dollars. But then that is one reason why we buy gold, to preserve or increase the value of our current wealth. Inflation, as measured by what it costs you to live a decent life, has increased far above the levels recorded by government agencies. This is OK in my Book, as Government agencies need some sort of standard of measure to go by for the average of the population. They need a benchmark that they can have some control over by their interventions or they serve no purpose.

I am, of course, talking about the Central Banks. No matter what they do, they can not control or truly influence the global price of Food and Energy. If they lower the short term rates to Zero, 0, as was done in Japan for a number of years the price of a barrel of oil would still go up if there was not enough to go around. It might make it somewhat less expensive to search for oil with borrowed money but if you can not find an Ocean of it then the prices will still rise higher; and maybe more so as easy credit allows people to use even more natural resources.

If the rains don't come, or don't come at the right times then the price of food too will rise. What influence can a Central Bank have on Nature by what it sets short-term rates at? Just ask King Canute.

As for Gold, well, they can influence the price of that commodity as we have seen over the years. When the worlds' Central Banks were dumping their Gold Reserves on the Markets we saw the prices of the glittering yellow tumble. These Central Banks were placing their faith in a Stable U.S. Dollar and ever expanding U.S. economy via purchase of US Dollar Denominated Instruments, Treasuries and even some GSEs, Government Sponsored Enterprises.

This exchange of Tangible wealth for Promissory wealth worked well as long as the instruments stayed ahead of or kept pace with inflation. In a hodge-podge Central Bank environment that was pre-Euro Europe the Buck was King as the standard of stability. This we can thank Paul Volcker for, as he showed that the US Federal Reserves was as serious about controlling Inflation as the Germans are, regardless of the consequences.

With the coming of the Greenspan Dynasty the US Dollar and US Interest rates seemed to be enjoying a, should I say it? I will say it, A Golden Age!

The price, in US Dollars, for Gold had a steady decline while US Interest rates and Inflation rates had a Jitterbug dance, not a Waltz. The setting of US short-term Interest rates is a tool that the Fed has always employed but now it was used not only for US but for Global Events as well, though never publicly stated as such. Actions always speak louder than words. As do their repercussions.

There was an old TV show called Racket Squad. It would always have a caveat that went something like this, "Beware the man who pats you on the back with one hand and picks your pocket with the other."

This is what the Central Banks have done to us. They have given us a false sense of economic stability, orchestrating mild declines and rapid recoveries, which is why they call Greenspan the Maestro. I personally think Midas is far better.

For those that are not familiar with the story or do not recall it, he loved gold. He loved gold so much that he wished for and was granted the ability to turn anything he touched into GOLD. Of course this ability does have its drawbacks. Food and drink would turn to Gold as soon as they came in contact with him, as did his daughter who kissed him; or something like that. The moral, of course is, be careful what you wish for.

We are now on the verge of significant economic turmoil in the U.S. brought about by the Sub-Prime fiasco. As I have stated before, sub-prime loans are not bad nor the cause of the problem. The problems were caused by excessive leverage due to low interest rates and easy access to cash. When that dried up, the borrowers, like Midas, went without food or drink. So what does Dr. Bernanke plan to do? Why, he plans on emulating the Maestro, and getting the music going again.

If he makes the magic work, he will be applauded by all as a fitting successor. All around will be the glittering statues and well-laid tables of inedible splendor. We will look ahead to a bright future. The U.S. Dollar will recover. The U.S. economy will pick up. New jobs will be created and all will be right with the world. Of course should this come to pass the price of Gold in U.S. Dollars will drop. It will sink like a rock in water. Maybe even faster than the last time, until the next crisis is created by the easy credit.