Ben Bernanke is confused. And no, it’s not just the monetary system that continues to confound him. This time it’s gold prices. During yesterday’s Congressional testimony Bernanke was asked about the surging price of gold and if that is a sign of no confidence in fiat currencies. He responded:
“Well the signal that gold is sending is in some ways very different from what other asset prices are sending. For example, the spread between nominal and inflation index bonds remains quite low – suggesting just 2% inflation over the next 10 years. Other commodity prices have fallen recently quite severely including oil prices and food prices. So gold is out there doing something different from the rest of the commodity group. I don’t fully understand the movements in the gold price, but I do think there’s a great deal of uncertainty and anxiety in financial markets right now and some people believe that holding gold will be a hedge against the fact that they view many other investments as being risky and hard to predict at this point.”
Mr. Bernanke is no dummy. I know I am a bit hard on him at times, but that is only because he is supposedly the Michael Jordan of the financial system so expectations are high. Unfortunately, he has performed more like Luc Longley (no offense to the superb Aussie readers here). Nonetheless, Mr. Bernanke understands that inflation pressures remain very low (even though he has failed to apply or promote the proper solution to our current balance sheet recession). Aside from gold prices there are no signs of inflation in the economy. But I believe gold prices are moving higher due to the public’s opposition to fiat currency, fiscal stimulus and what is generally viewed as continued “money printing”. This is highly irrational in the long-term in my opinion and creates the potential for gold to turn into a bubble is looking increasingly high.
Gold prices have surged this year as the Euro crisis has created increasing concerns over the viability of fiat money. I have previously discussed the great irony here. Gold is viewed as a hedge against the potential collapse of paper currencies . It is seen as the ultimate safe haven currency. The Euro crisis has created an incredibly misguided belief that the viability of paper money is at stake. It has caused the increasing rally cry for reduced government spending and continued shrieking from deficit hawks who haven’t differentiated between the currency system in the EMU and in most other developed nations. Ironically, the Euro is more a reflection on the gold standard than the paper currency systems in place in nations such as the USA or UK.
Is it irrational for gold prices to move higher in the near-term? Absolutely not. This belief that paper money is flawed is likely to persist. Investors and governments are truly convinced that the USA is the next Greece. Last weekend’s G20 meeting was a clear sign that governments are giving up on fiscal policy. This creates increasingly high chances of global instability. After all, I don’t think there are too many people out there who would deny that the rally in risk assets and the glimpse of recovery was due to government intervention. The CBO’s recent report verified as much.
This move towards fiscal austerity is eerily similar to what we saw in Japan in the 90’s and could very well drive us towards continued recession as we talk ourselves off the edge of the cliff. In the end, however, the Euro crisis will pass. That is unlikely to occur until European leaders recognize that their single currency system is inherently flawed (just as the gold standard was) and that means we could see substantially higher gold prices as investors continue to rush into gold with the belief that gold can serve as a viable reserve currency (something that has already been tested in a global economy and also something that has already failed). All of this increasing worry in Europe is likely to increase the odds of a gold bubble. The great irony here is that while many are worried about a bubble in treasury bonds we are likely to continue seeing increasingly high chances of deflation and/or very low inflation while a bubble grows in gold prices. The inflation trade will continue to fall flat on its face, but gold will continue to do “something different” as Mr. Bernanke so eloquently said.
How do I see such a scenario unfolding? I believe there is a fairly high chance of an eventual defection and default in Europe. After all, there is no good solution in the region and the debt problems will persist until something forces the EMU’s hand. If this in fact occurs gold prices could very well reach stratospheric levels. But ultimately, paper money will survive in its current form no matter what happens to the Euro. Cooler heads will prevail and investors will realize the the Euro crisis is unique to that currency system and not a reflection of the floating exchange system as a whole. As this occurs gold investors will realize that the risk of inflation never materialized and that the Euro was not in fact a flaw in paper currency, but a flaw in single currency systems. Should this occur I believe we will see a spectacular collapse in gold prices not unlike the move in the 70’s.
In the near-term, however, dollars, bonds and gold are likely to remain the safe haven trades of choice as deflation remains a near-term risk and investors continue to misinterpret the Euro crisis as a fiat money crisis. Ultimately, one of the above will end in heartbreak for millions of investors and I for one am not betting against the solvency of the USA.
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So near term bull and long term bear on gold?
How has he performed compared to Andrew Bogut?!
SO gold to the moon and then a crash; bold call that. not
I actually think its a very bold call.
Given that 99.7% of people don’t understand the monetary system, i think TPC is making a huge leap of faith to suggest that investors will eventually realise the differences between the monetary systems. They are yet to realise thus far.
Maybe I’m too bearish on that bit…but it goes without saying that if people one day do figure it out, then it is an absolute certainty that gold will be stuffed!
Gold is as irrational as TB-US… Technically in the same configuration. Short-term bull, but one-life move on the short side on long term. The overall sovereign is bearish on LT. One world, one market.
…’in the long time’ he says….well in the long time we’ll all be dead, hehehe…. sucker
There is a simple reason gold is ‘out of line’: it is true money. All the people who treat it like a commodity are just not getting the message. But I am not surprised: if you have lived in the fiat era of 1970-2010, you have forgotten what real money ought to be. And that is NOT paper backed up by debt.
like i say on my surfboard(and a few other places)……if it swells, ride it……
everything is a “sell” sooner or later……its about when
there would still be an ultimate investment for fear(irrational or otherwise) if gold didn’t exist(i guess then we would have the silver-haters).
i won’t risk alliteration by posting the DOW:gold historical chart again here
a ounce of gold will buy the DOW, or at least half it,before this is over. whether it makes sense or not……..i am constantly amazed by the things human beings do that make alot less sense than buying gold.
euro and US real estate unwinding will be more convulsive and/or prolonged then most think.
the rope ben is pushing on might well ultimately become a “spring”……i know ya’ll have seen those slip out of their confines….if not,no matter…….deflation is working for gold
I agree, it is impossible for a country to default on debt denominated in the currency it prints, in a floating exchange regime. That country can always print money and buyback treasury debt. In so doing, the supply of the currency increase. There are 2 ways new printed currency can go: real economy or financial markets. We are in a world of excess supply ad deleveraging balance sheets, real economy doesn’t want new money, at any price, so the new money created by central banks (FED and BoJ in primis) is going into financial markets, inflating the price of risky investment assets (during positive mood cycles) and “safe” investment assets (during risk averse cycles).
In any way, if money go in real economy (inflationistic world) gold increase,if money go in financial markets(deflationistic world)gold increase. Gold is a currency, the first currency. The value of gold increase if the supply of other currencies increase beyond the amount necessary to accomodate GDP growth.
Gold is not a “normal” commodity, it is a store of value.
http://pogoprinciple.wordpress.com/2010/06/09/the-golden-grimace-part-nine-gold-the-dollar-and-superfluous-work/
Downloading on Longley when you had your choice of both Bill Wennington and Jud Buechler? Just don’t get it…
Buechler. How could I forget?
Forget the gold-inflation-deflation mumbo jumbo.I buy gold because in the ABBA LERNERs keynesian world = paper money currency system all the private financial wealth is in the goverment hands and at last all the goverments will destroy their currencies buying its debts.
TPC,
I am new to this site. So far, very good. Thanks. So what is the solution, in your opinion?
The real bubble is of course fiat money. Way too much of it has been printed, completely out of line with economic growth. Six newly printed dollars (i.e. debt) created 1 dollar of economic growth in the past decade. That is a clear sign something is terribly wrong. Gold simply signals that in 2001 it was game over for normal growth. Since then the U.S. has experienced negative GDP (see shadowstats.com), but Greenspan and co. has sold us the story that inflation = economic growth. Alas, it is not.
Gold will perform great during money printing and disastrous monetary policies. I don’t see an end to that soon, so as long as we have Bernanke, Geithner & Obama the bull market in gold will continue. Von Mises taught us that the 2 outcomes of a credit crunch are deflation, or destruction of the currency. They have chosen the 2nd option, Bernanke’s sole goal is to prevent Great Depression II from happening. So he will kill the dollar, which is hugely bullish for gold.
“Von Mises taught us that the 2 outcomes of a credit crunch are deflation, or destruction of the currency. ” Nout Wellink
How about a third solution from Moses, not Mises, debt forgiveness (Deuteronomy 15:1, Leviticus 25)?
Here’s how:
1. set reserve requirements to 100% 2. Print a sufficient amount of debt-free legal tender and distribute equally to all adults in the population. This will allow debtors to pay down their mortgages to market price levels and would also compensate savers for years of artificially suppressed interest rates. Note that the banks would be made whole in nominal terms but would suffer relatively in real terms. The long term solution is to repeal legal tender laws, the capital gains tax, government deposit insurance and allow alternative currencies.
TPC, OK, I don’t get it what do you want Bernanke to do on the monetary side? He’s got interest rates at near zero, he keep cheer leading the economy at every opportunity, he’s opened up the swap lines in case there is a credit freeze up in Europe, so what more must he do? Are you suggesting he do more quantitative easing?
I’m not sure what else he can do, the fiscal side is in the administration and congress’s hands, so Bernanke can’t do much about that other than to encourage them.
Agreed. I am a bit too hard on him. He is powerless in terms of what he can actually do. But he opines on fiscal policy all the time and carries a huge amount of influence. He should recognize by now that monetary policy has failed and that we need to better understand our fiscal options. He has never expressed such an opinion.
TPC, if he did that publicly, what message would that be sending the markets and the main street. Now is not the time to drive fear into the markets, he needs to continue to be the cheer leader, he has no choice. Did he ever? In the back ground I’m sure he’s pushing for another stimulus, or at least asking the WH to tone down the anti business rhetoric. “Whatever it takes”, wasn’t that the catchcry from him and Geithner?
Let’s hope they keep the pedal to the metal, before they decide to ease up of stimulus measures (both monetary & fiscal). Now is not the time to pull back.
He’s a fairly outspoken man. I am not saying he should admit that monetary policy has failed. Absolutely not. But I do think he should try to push Congress in the right direction. After all, that is basically what these hearings are for. Not only to keep him accountable, but for these Congressman and women to pick his brain and ask for advice and guidance. His comments regarding the deficit and our debts instill this fear mongering campaign that we are going bankrupt. He certainly knows we can’t go bankrupt (he has said as much), but for some reason he doesn’t seem to be able to advocate an approach that might be more geared towards Main Street. I don’t get it. It could be politics or it could just be that he doesn’t get it. But he should. Anyone can recognize by now that his Wall Street driven recovery has not solved the underlying problems. It has been a terrible form of trickle down and it has failed. He should recognize this and push Congress in the right direction. You would think that a Republican might even advocate tax cuts, but I don’t recall him ever advocating such a thing.
Some thoughts I’ve had on gold:
1. Where is it written that the average rate of mining gold shall be roughly the same as the average economic growth rate?
2. Someone has said that it is silly to dig gold out of the ground just to bury it again in bank vaults. Isn’t this a waste of human effort?
3. Central banks hold vast amounts of gold. Is gold a fallback position for the central banking establishment? Why should we let central bankers, who caused this problem, set the ground rules?
4. Keynes said gold was a “barbaric relic”. I am no Keynesian but he does have point, doesn’t he?
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