January 27, 2009

The Rise of Gold and Fall of The Dollar

By Julian Dunraven, J.D., M.P.A.

Honorable friends:

Last month I wrote that the bailout total, which has now reached more than $8.5 trillion, with another $850 billion stimulus to come this year, will eventually force us into dangerous levels of inflation. I thank the Bangor Daily News and Bridget Johnson at The Rocky Mountain News for picking up on that post. Since then, although the Fed printing presses have been running at a frantic pace, nearly doubling the money base, much of it has not yet reached the money supply. That is about to change.

As the credit crisis hit and companies began to deleverage in earnest, selling anything they could to obtain dollars and pay down debt, U.S. treasury bonds sold very well. Our people, seeing the credit crunch and falling prices, began to fear a deflationary trend and flocked to treasury bonds as well. Truly markets are psychologically driven—and often insane. More rational heads have reminded us that real deflation requires a contraction in the money supply—which the Fed’s printing has made all but impossible. It seems, however, that reason is beginning to reassert itself.

U.S. treasuries are now selling at almost zero percent interest rates. As a result, $1 million invested into a one month treasury bill, rolled over each month, will earn you only a meager $100 annual interest. A one year treasury bill for $1 million will earn you only $4,300. No one can live off such pathetic returns, certainly not our retirees. As for other governments, such returns offer little incentive to continue financing our debt, which increasingly looks to be utterly unmanageable. As a result U.S. Treasury sales are beginning to decline.

As the Ludwig von Mises Institute points out, our biggest creditor nations are unlikely to increase their investment. Japan has been a net seller of U.S. Treasuries and it has its own problems to deal with from demand destruction affecting its exports. OPEC nations are suffering from falling oil prices and their own resulting economic woes render them unable to finance more of our debt. The Caribbean banks are suffering from the credit crunch forcing liquidity and in no position to offer help. That leaves China, which is passing its own $585 billion stimulus, of which the government is providing only $170 billion, leaving the rest to be financed out of its foreign exchange reserves—such as U.S. treasuries.

To further complicate the matter, Chuck Butler’s Daily Pfenning yesterday picked up on news that Chinese officials are now contemplating selling U.S. Treasuries in part out of retaliation that the U.S. government has cast blame on China for the global financial crisis. Yu Yongding, a former member of the People's Bank of China's policy board, also warned that “supply of Treasuries may far exceed demand in the future.”

Thus, as the Fed finds itself unable to sell sufficient treasury bonds to finance all the government spending, it will have no choice but to begin quantitative easing, a polite term for printing money and injecting it directly into the money supply. In other words: massive inflation.

As part of their efforts to accomplish this enormous monetary expansion and devaluation in a vain effort to stimulate the economy, the Ludwig von Mises Institute points out that the central banks have finally abandoned their attempts to artificially suppress the price of gold through naked short selling and dumping. Slapstick Politics discussed this inevitability back in October.

As I predicted last month, the result of all of this has been a drop in the value of the dollar and a precipitous rise in the price of gold as people try to find a way to preserve their wealth. The other major fiat currencies of the world are no better, as James Turk of Gold Money illustrates. The central banks of the world have all embarked on this strategy of bailouts and spending together, and they are all devaluing their currencies together. That trend is likely to continue for some time, and gold remains the best protection against it.

For those of you who still have yet to purchase gold and are cringing at its current price surge to around $900 per ounce, there are some hopeful signs to watch for. Although I do not think the bailouts and stimulus packages will be at all effective at solving the financial crisis in the long run (a topic Slapstick Politics will continue to address), I do expect them to produce a short term boost in confidence in the near future. The strange aura of hope that the Obama administration has coming into office will assist this as well. There may also be another period of deleveraging in the near future. In either scenario, several investment specialists speculate that the price of gold could plummet back down to $650-700 per ounce. If that happens, it would be a wonderful time to purchase. Before the central banks have completed their efforts at quantitative easing, most gold investment experts are estimating the price of gold could rise to anywhere from $1,500-5,000 per ounce. The Ludwig von Mises Institute goes quite a bit further, speculating that gold could climb to almost $10,000 per ounce. While I tend to lean toward the more conservative estimates, gold continues to provide the best possible protection against the inflation and devaluation the central banks of the world are now foisting upon us in what is perhaps the greatest theft of wealth in history.

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