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There can be little doubt that Fed Chairman Benjamin Bernanke
has been a very, very good friend to gold investors. However, some of those
who have benefited from his largesse now fear that the recent selloff in gold
indicates an imminent end to Bernanke's monetary high-wire act. Most assume
that a cessation of the Fed's stimulative efforts, if it were to occur, would
spell the end of gold's bull run. But a closer reading of Bernanke's economic
philosophy and the Fed's own recent history, shows that once central banker
begins a strenuous routine starts, it is very hard, if not impossible, for
them to dismount.
It is widely believed that the unemployment rate, core inflation
and home prices are the three key pieces of economic data that Bernanke and
his Fed cohorts rely upon when formulating monetary policy. Although other
data points, such as regional manufacturing surveys and the producer price
index (which have rebounded significantly in some cases) attract some
attention, they do not carry near the weight of the big three. With the
unemployment rate remaining north of 9.4%, YOY core CPI inflation still less
than 1% and the Case/Shiller Home Price Index down .8% from the year ago
period, the Fed is in no mood to downshift. If anything, my guess is that
Bernanke will step on the gas.
More importantly, in light of Bernanke's often stated conclusion
that premature Fed tightening in 1937 and 1938 led to a prolongation of the
Great Depression, even if the big three metrics were to show marked
improvement, any future increase in interest rates will be moderate and held
in abeyance for as long as politically possible.
Despite the fact that some economic data is improving, the
foundation of the economy is getting worse. Consumers are now increasing
their borrowing again--as evidenced by last week's number on consumer
credit--and our government is now massively overleveraged. But leaving alone
the deteriorating nature of these forward looking metrics, the Fed's own
history provides unexpected good news for those holding tight to their gold
positions.
The Fed began its last round of rate hikes in June of 2004 when
Fed Chairman Alan Greenspan began a sequence of consecutive 25 basis point
increases. The Maestro bumped rates 14 times before passing the baton to
Bernanke in February of 2006, who continued the program with three more
¼ point increases. The combined efforts took rates from 1% to 5.25% in
the span of two years. However, the tightening program did nothing to tarnish
the luster of gold. Here's why.
Since the Fed increased interest rates very slowly from an
extremely low level, money supply continued to expand during the long, slow,
deliberate campaign of 25 basis point increases. From June 2004 through June
2006 the M2 money supply increased 9.3%, rising from $6.27 trillion to $6.85
trillion. Total loans and leases from commercial banks jumped from $4.61
trillion to $5.71 trillion during that same time period, an increase of 24%.
As a result, over the time that the Fed's dynamic duo waged their phony
war against the asset bubbles of the mid 2000's, the price of gold increased
from $395 to $623 per ounce.
The truth is that increases in money supply and bank lending
aren't curtailed very much by a Fed Funds target rate that is increased very
slowly from a starting point that is decidedly below the rate of inflation.
Currently, Fed Funds is decidedly below the rate of inflation, and is likely
to stay there for some time. Therefore, investors need not necessarily fear a
run on gold once Bernanke eventually lifts rates from zero percent...if he
ever makes that decision.
In addition, investors should keep their eyes on the damage
created by these ultra low rates. An enormously destructive housing bubble
grew out 1% and 1.5% rates that were in place from November of 2002
through August of 2004. In our current round, the Fed has kept interest rates
near zero since December 2008...more than two years! Why should we expect a
different outcome this time around?
A key point to mention is that the credit crisis and collapse of
the housing market were not caused by a the Fed bringing rates to 5.25%.
Rather real estate prices simply went too high because rates were too low in
the years prior. The low rates were the problem. And once home prices became
unaffordable to most consumers, banks then became insolvent because millions
defaulted on mortgages. After their capital became significantly eroded they
were subsequently unable to lend.
The bottom line is that if Bernanke should ever attempt a
"dismount" from massive monetary easing, investors should take
solace not because he is likely to "stick" the landing, but because
the exercise will likely be so futile that owners of gold should continue to
shine.
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A
15-year industry veteran whose career began as a trader on the floor of the
New York Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
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