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This week,
world attention finally shifted away from debt problems in Europe to the
unresolved and worsening debt crisis here in the United States. The Congressional
Super Committee, which had been created over the summer to postpone making
tough cuts, chose to avoid responsibility itself. In so doing, the Committee
has followed the path of least resistance and maximum irresponsibility. Given
the likely after-effects, the outcome should be judged as criminal
dereliction of duty. It should now be crystal clear to even the most casual
observer that a solution to the U.S. debt crisis will not come from within,
but will be imposed, perhaps brutally, from without.
But while the
media focused on Washington, institutional investors remained focused on
Paris and Brussels where beleaguered European banks continue to suffer from
dangerous overexposure to bad sovereign debt. To avoid these risks,
institutions are locked into a flight to what they perceive as 'safety.'
Despite the abject failure of American politicians, many of these
institutions may be flooding into U.S. dollars and U.S. Treasuries, driving
yields to historic lows.
This
unexpected fund flow is acting as a fortuitous camouflage for the U.S.
Congress. With the U.S. dollar rising, and U.S. interest rates falling, the
inability of Congress to curb its profligate spending habits appears in some
eyes to be less urgent. At the same time, commonly held secure investments
such as precious metals, appear to be increasingly volatile and viewed
increasingly as less of a safe haven.
Both these
conclusions are fatally flawed and risk serious investor disappointment.
First, it is
likely that a collapse of either the euro or the European banking system will
flow rapidly to America, threatening U.S. banks, the U.S. Treasury market and
even the continued viability of the fiat dollar-based monetary system. In
short, the U.S. dollar and U.S. Treasury bonds are two massive but latent
bear traps. Investors should be wary of both.
Second, the
safe haven aspects of precious metals, especially that
of gold, have been distorted by the Fed. Most debtor central banks and
politicians would be pleased by any reduction in the embarrassing 'safe
haven' image of gold, and have historically done all that they could to
undermine confidence in the gold market.
It is
important to recognize the major distortion that Fed Chairman Bernanke has
thrust into the gold price. Under his guidance, the Federal Reserve has
abused its monopoly power to manipulate short-term interest rates, which are
currently 1.5 percent below the level of inflation, a level that has
inflicted, and will continue to inflict, untold damage on the economy.
Negative real rates deny investors a secure economic repository for their
cash. In reaction, many have used gold as an alternative to replace bank
deposits. This added demand has boosted the marginal prices of gold and
silver.
Today,
precious metals appear to track stock markets. When stock markets rise,
investors tend to hold their accumulated cash not in zero interest bank
deposits, but in precious metals, driving prices upwards. When stocks fall in
price, investors sell precious metals to raise cash to meet normal cash requirements
including redemptions and margin calls, adding enormously to the marginal
price volatility of precious metals. However, this volatility does not
foreclose on gold's ability to retain its value when confronted with
additional rounds of currency debasement.
Second,
precious metals are not merely a hedge against inflation. They are insurance
also against financial catastrophe. With quantitative easing likely to be the
recommended panacea for recession, we may face economic recession accompanied
by financial inflation and a threat to the fiat monetary system. If this
disaster transpires, one major safe haven could be precious metals. As a
result, Fed inspired short-term price volatility should not deter investors
accumulating positions on price dips.
In short, the
current news from both sides of the Atlantic should provide further reasons
to feel comfortable with precious metals.
John
Browne
Euro Pacific Capital, Inc.
John Browne is a former member of the UK
Parliament and a current senior market strategist for Euro Pacific Capital. Click here to learn more about Euro
Pacific's gold & silver investment options. For a great primer on
economics, be sure to pick up a copy of Peter Schiff's hit economic parable, How an Economy Grows and Why It Crashes
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