I’m finally back in the US! Last week, I heard Dr. Marc Faber, of GloomBoomDoom
fame, on CNBC India. While gold is currently at a whopping $973/Oz, on that day gold had briefly touched $950/Oz for the first time ever.
Dr. Faber said two things that were very interesting:
1. Gold is a bargain at $950/Oz
2. Fed Chairman, Ben Bernanke doesn’t understand how the economy works
Seems like he agrees with Jim Rogers!
I’ve been advising everyone to invest in gold since it was $500/Oz. Of all the people I know, maybe 3 or 4 actually followed my advice and bought some gold. Most people thought I was stupid and vehemently disagreed with me. Most of their arguments consisted of the following points:
1. Gold has been a terrible investment for most of history and in fact had declined from its peak in the early 80’s for 17 years.
2. Gold doesn’t pay interest and you’re blocking your money.
3. Gold has no real use. It’s just some rich people who are propping up the prices.
While, these are all valid points, they didn’t touch the main point of gold being a store of value. In times of uncertainty and times of hyperinflation, gold always does well. Whenever there is a lack of confidence in the banking system, gold prices tend to shoot up.
John Lee, portfolio manager at Macau Capital Management, has a good explanation:
Banks create dollars out of thin air and loan them to people. Even though money is created out of thin air, once the borrower pays back the loan, the transaction is complete and those borrowed dollars perish in bank’s books. In this scenario, the dollar’s purchasing power is preserved through non-dilution.
However, as we have witnessed through the recent subprime fiasco, many parties are getting away without fulfilling their obligation to repay a loan. Institutions were bailed out as the Fed bought their mortgage positions at face value with new money. Consumers were bailed out as lenders were elbowed to freeze foreclosures, freeze rate resets, forgive loans, and make lower payments.
Such compromises erode confidence in the system. If one person can get dollars through borrowing without paying back, and yet another had to work to obtain and save dollars, it is surely not an incentive to earn and keep dollars. Rather, it is a no brainer to borrow dollars and spend unabashedly. Savers are the most risk averse bunch of people, and when the monetary rules are muddied, they will opt out. This is how a run on the dollar starts.
Interestingly, unlike Faber or Rogers, Lee maintains that Bernanke does know what he’s doing and that its the correct course of action for the Federal Reserve.
Today, the USA is the world’s largest debtor nation. Regardless of how high oil is, there is no room to raise rates with tens of trillions of dollars in debts to be serviced.
Don’t blame Bernanke for our problems; even if Volcker were to be the chairman today, he would have acted in exact same way as Bernanke did.
The ideal dream for debtors is inflation, which is precisely what the Fed is advocating – expanding money supply through lowering interest rates and direct handouts. The Fed’s action is entirely logical acting on behalf of the average American, which is heavily in debt.
While I would contend that debasing a currency just because you can’t afford the interest payments is a wrong thing to do, Lee does at least agree that fiat money always results in hyperinflation.
The deflation camp has been on the wrong side throughout EVERY fiat money experiment thus far. The bear camp contends that the debt burden will eventually become so large that eventually the debt bubble will blow and the prices of everything stocks to real estate to copper and zinc will collapse.
Fiat money systems have always resorted to hyperinflation and destruction of the currency without fail. If hyperinflation could be avoided in a fiat system by the creation of the Fed, the Argentines in 2002 surely would have figured it out and avoided their hyperinflationary disaster.
He also thinks that the Federal bailout will lead to a further weakening in confidence which will cause the dollar to drop further.
The idea that the Fed and the government will allow debt cleansing lasses faire style is patently absurd in my opinion. Central bank action has spoken louder than words in the past six months as record $1 trillion+ has being printed to rescue banks. For instance, England’s largest mortgage lender, Northern Rock, has been nationalized. And as for the consumers, loan amounts are reduced without penalty or conditions, mortgage rate resets are postponed, federal guarantee limits are set to increase.
Here we go back to psychology. It is not so much about the amount of bail out money being printed, but rather that the smart money took issue with the way the handouts were given unconditionally across the spectrum. Confidence in the dollar was further eroded.
Ok, so what’s his point? Lee thinks that gold is heading much higher.
Gold is money and a refuge of capital when a defective fiat money system shows its ugly head. Gold is universally recognized, portable, divisible, liquid, and limited in supply which makes it the only real viable option as store of wealth. Today’s gold price has not fully priced in dollar’s deep and terminal issues and there is nothing that can be done to stop the further rise in gold. The Fed can talk tame CPI to try stabilizing commodity prices but the effect will be limited. Mind you, gold’s rising popularity should be seen as positive; the fall of the dollar system levels the playing fields for global consumers and producers.
The markets can easily handle $3,000 – $5,000 oz. gold in the near term horizon with minimal disturbance. It is when gold rises too much over $5,000 too fast that we might start to worry about global inflation panic.
Wow, gold at $5,000/Oz! That’s a bold prediction. I’m not sure if I agree with him, but I’m still sticking to my belief that gold will reach somewhere between $2,500 and $3,000 in this cycle. Look for gold to break $1000/Oz around the middle of March when Bernanke drops the federal funds rate another 50 basis points.
And whether or not Bernanke knows anything about the economy is still up for discussion. The popular consensus seems to be that he doesn’t!