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Like beauty, the value of gold and the dollar are in
the eye of the beholder, which at times can be entirely subjective,
arbitrary, and irrational. This is much akin to financial speculations
throughout history from stamps to sea shells.
Everyone has their theory on why the US dollar is
sagging – huge deficits, slowing economy, high inflation, artificially
low interest rates, subprime issues etc.
I am not sure if those factors are the cause or the
effects of a sagging dollar.
·
A $600 billion dollar Trade Deficit: It is a drop in
the sea in magnitude when compared to world’s investable
dollars, pegged at over $100 trillion dollars. It is a fallacy to analyze the
dollar based on trade deficits, much like analyzing the gold price based on
physical supply and demand.
·
A Slowing Economy: The economy grew 2% in 2002 when
the dollar index reached all time high of 120. In 2007 GDP also grew 2% yet
the dollar has just reached all time low of 74. The correlation between GDP
and the dollar index is far from distinctive.
·
Rising Inflation: Inflation is properly defined as
an increase in money supply, which has been consistent at 10 - 15% a year
growth in the last 20 years. While gold is reaching new record highs by the
day, the money supply growth has actually slowed compared to past years as
fewer people take out mortgages and loans.
Talk about a floating concept. The euro is no less abstract than the dollar, yet it now
trades at a 50% premium to the dollar when it once traded at a 12% discount?
The dollar has stayed fiat for over thirty years
since Nixon closed the gold window. If all dollars are fiat monies, and
intrinsically a dollar is worth nothing today as it did ten years ago, then
why the dollar crisis now?
The coming dollar crisis, in my view, has more to do
with psychology and confidence. Let me expand.
If a co-worker asked you for a $100 handout, you
would probably say no. If he asked you for a $100 loan which you gave and a
year later he couldn’t pay back, the result is a $100 loss, which is no
different than the handout you had first refused. You were tricked.
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.
Deflation and the Fed are mutually exclusive
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.
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.
The Fed is not the problem or the solution at this
point.
The Fed’s official stance is to ensure price
stability. Many however begin to question what the Fed is doing by lowering
rates amid record oil prices.
The USA
today is 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.
What’s next? Gold and prosperity.
The Sun rises in the morning and sets in the
evening. There is nothing to stop it.
At this point, all the cards have been dealt and
exposed. 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. My take is that over the next few years
gold will establish a new equilibrium to fiat currencies, albeit at much higher
level than today’s $950/oz.
By :
John Lee, CFA
www.goldmau.com
John Lee is a
portfolio manager at Mau Capital Management. He is a CFA charter holder
and has degrees in Economics and Engineering from Rice University.
He previously studied under Mr. James Turk, a renowned authority on the gold
market, and is specialized in investing in junior gold and resource
companies. Mr. Lee's articles are frequently cited at major resource websites
and a esteemed speaker at several major resource
conferences.
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