U.S. POLITICS, ECONOMIC POLICY, AND THE FUTURE PRICE OF GOLD

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Gold thrives on political and economic uncertainty . . . and we’ve got plenty of that now that the Republican Party has seized control of the House of Representatives and narrowed the Democratic majority in the Senate.  What’s more, the U.S. Federal Reserve, America’s central bank, is adding to the uncertain political and economic landscape as it embarks on another large dose of monetary stimulus.

Without a doubt, the new arithmetic on Capitol Hill — along with the Fed’s recent policy shift — reinforces the bullish case for gold and raises my confidence that gold prices will rise to $2000 an ounce, then $3000, and possibly higher peaks over the next few years.

Irreconcilable Differences

There’s plenty of rhetoric from some Congressional leaders and the Obama Administration about “working together” to solve America’s economic problems.  But, in the end, irreconcilable philosophic differences on the role of government suggest that the ship of state will remain rudderless — at least with respect to fiscal policy — until the next federal elections in two year.

Not only will the new Republican majority in the House confront a liberal Administration, but there could also be a nasty struggle for control within the Republican Party between its now-more-powerful conservative wing and party moderates . . . and within the conservative wing between the traditionalists and the unconventional Tea Party bloc that has now won a seat at the head table.

Republican leadership will demand across-the-board tax cuts, reduced Federal spending, and rolling back the recently enacted health-care program.  It’s hard to imagine liberal Democrats will swallow the Republican medicine.  More likely, we face more gridlock and more acrimony on Capitol Hill — in short, a dysfunctional government that is incapable of dealing effectively with America’s serious economic problems.

Three Fiscal Indicators

Tax Policy: One of the early indicators of future fiscal policy will be the decision taken to extend or let expire the Bush-era tax cuts that run through the end of this calendar year — or just possibly accept some sensible compromise that would extend the cuts another year or two for all but the wealthiest few percent of tax payers.

Rather than pursue what some consider appropriate counter-cyclical fiscal policy, failure to extend the Bush tax cuts will raise taxes at just the wrong time, taking money and spending power out of the household and small-business sectors.

Others argue the expiration of the Bush-era tax cuts are just the right medicine to reign in our outsized Federal budget deficit and borrowing requirement, a first step toward restoring confidence in the U.S. dollar both at home and overseas — but fiscal restraint at this juncture could easily backfire, slowing or even reversing the hoped-for economic recovery.

In any event, neither course – raising taxes enough to achieve a quick and significant reduction in the Federal budget deficit, nor cutting taxes enough to greatly stimulate a sluggish economy — is politically feasible.

How this controversial fiscal-policy issue unfolds, and it’s long-term effect on the health of our economy, will be one of the big issues affecting gold, the dollar, and other world financial markets in the weeks ahead and, possibly, for years to come.

The Debt Ceiling: Political analysts and economists are also wondering how Congress will deal with the national debt ceiling that now prohibits Federal borrowing above the current legal limit of $14.3 trillion.  Unless Congress votes to raise this ceiling, the Treasury’s borrowing authority will expire early next year.

In the past, Congress perfunctorily increased the ceiling each time Federal borrowing approached its legal limit.  Now, however, a handful of incoming anti-debt, anti-government Tea Party legislators, led by libertarian Republican Senator-Elect Rand Paul, could stall Congressional action to raise the legal limit.

Without the authority to borrow, the Federal government cannot function.  Public spending on even the most essential programs and services would grind to a quick halt.  The Treasury would be forced to default on maturing debt — much of which is held by foreign central banks — and we could find ourselves in a global financial crisis of massive proportions with the dollar sinking fast and gold moving sharply higher.

State & Local Bailouts: Another important — but less-discussed — fiscal policy issue that may soon capture more attention on Capitol Hill and in the financial press is the increasing insolvency of many state and local government entities across the nation.  With the new, more conservative, majority in the House of Representatives the hoped-for bailouts from Washington may not be forthcoming.  Many states operating in the red (including California, Texas, New York, Michigan, and others) must balance their budgets — meaning further belt-tightening, service cuts, more lay offs of public employees (including teachers, policy, firefighters, and office workers), and higher local taxes, all of which will be a further drag on the national economy.

The Fed to the Rescue

With the Obama Administration and a more conservative Congress at loggerheads, it is likely that America’s central bank, led by Federal Reserve Board Chairman Ben Bernanke, will be the only agency capable of acting forcefully in the face of a continuing recession-like economic performance characterized by persistently high unemployment.

But all the Fed can do is print more money — what economists and financial journalists call “quantitative easing” or simply “QE.”  The Fed accomplishes this magic trick by purchasing securities, usually Treasury notes or bonds, in the open market or directly from the United States Treasury.

In addition to injecting more liquidity into the financial system, the Fed’s purchase of securities lowers medium- and long-term interest rates.  It is hoped that lower rates will encourage additional private-sector borrowing — borrowing to finance new productive investment as well as borrowing to refinance existing loans (including home mortgages) at lower interest rates and reduced carrying costs.

Quantitative easing also depresses the U.S. dollar exchange rate as excess dollar liquidity in the United States seeks higher rates of return abroad.  Dollar devaluation against the currencies of those countries running big trade surpluses with the United States will improve our international competitiveness, support American exports, restrict our imports, benefit domestic business activity and create more jobs.  Dollar devaluation is typically associated with gold-price appreciation — and this is yet another factor supporting our bullish outlook for the yellow metal.

The Fed began its policy of quantitative easing with a “shock and awe” spree of monetary creation, purchasing $1.725 trillion in U.S. Treasury, other Federal agency, and Fannie Mae/Freddie Mac mortgage-backed securities. That program, often referred to as QE1, ran from December 2008 to March 2010 — and was an important bullish factor propelling gold prices higher during the period.

Now, the Fed is embarking on a second tranche of quantitative easing.  Last week, following its early November policy meeting, the Fed announced its intention to purchase another $600 billion more in Treasury securities before the end of next year’s second quarter.

In the absence of sensible fiscal-policy alternatives, Fed Chairman Ben Bernanke has chosen, in my view, the least-bad policy path by adopting more aggressive monetary stimulus at this time. Without more action now, the economy would very likely sink further, new job creation would slow further, and unemployment would surely rise.

Underpinning my very bullish gold-price is the expectation that persistent recession-like conditions, especially unacceptably high unemployment, and a continuing fiscal-policy logjam in Washington will force the Fed to adopt still-more stimulative monetary policies for at least another couple of years — policies that sooner or later will be reflected higher U.S. consumer-price inflation, U.S. dollar depreciation, and significantly higher gold prices.

No Quick Fix

All of us want to see policies that will quickly right the economy, rev up business activity, and put the unemployed back to work.  But, unfortunately, a quick fix is not possible.

Few recognize that America’s recent economic problems are structural and were decades in the making, a consequence of excessive household and government spending that was bankrolled by consumer, mortgage, and public-sector borrowing and insufficient productive investment.

America spent, not on updating our national infrastructure or developing 21st century industries or training students and the workforce for the jobs of tomorrow.  Instead, we became a nation of shopaholics, buying things we didn’t need with money many of us didn’t really have, while our government spent excessively on the cost of empire and on social programs that were of admirable intention but no one wanted to pay for.

Countercyclical monetary and fiscal policies cannot fix these structural problems.  To thrive again, we must reduce our outstanding public-sector and private-sector debt — measured as a percentage of gross domestic product or national income.  Contrary to popular belief, higher inflation could be part of the solution.

Inflation Intentions

Although the Fed is officially targeting a small rise in consumer price inflation, I believe Chairman Bernanke is well aware of the much greater inflationary potential arising from the program of quantitative easing.

Printing more money may raise the hackles of sound-money advocates and surely won’t be appreciated by foreign central banks and others holding U.S. dollar debt — but higher domestic inflation and a depreciation of the dollar against the currencies of countries running persistent current account surpluses makes sense and may be the least painful road back toward prosperity.

Inflation erodes the real value (or purchasing power) of outstanding debt and lowers the ratio of total debt outstanding relative to nominal gross domestic product or national income.  Once our debt-to-income ratios are restored to “normal” or “healthy” levels, sustainable private-sector and public-sector spending can get the American economy moving again.

Some will argue that inflation is an unfair “invisible tax” on our creditors . . . and this is certainly true — but so is the lack of employment opportunities for most of our unemployed and the loss of wealth suffered by most American households.

The stagflation of the 1970s — a period of sluggish economic growth and high unemployment — demonstrates that high inflation and a falling dollar can occur even with low rates of capacity utilization and high rates of unemployment, what economists euphemistically call economic slack.

Just as the decade of stagflation gave way to economic renewal during the 1980s, higher inflation in the next few years could ultimately give way to renewed economic strength.

Wise economic policies — although unlikely given our wide domestic political divides — could lessen the pain and accelerate the return to economic health.  But, whatever policy path we find ourselves on, the United States faces difficult times that will be reflecting in a continuing long-term appreciation in gold.

Filed under: Gold Briefs | American Precious Metals Advisors, central banks, economics, economy, fiscal policy, gold, gold investment, gold price, inflation, Jeffrey Nichols, monetary policy, money supply, Quantitative Easing, U.S. dollar|No Comments

U.S. Elections, Economic-Policy Prospects, and the Price of Gold

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America’s Congress is up for grabs in just a few days — and world financial markets have a serious case of the jitters. No one knows for sure what the make-up of the U.S. House of Representatives and the U.S. Senate will be next year . . . but it’s hard to imagine we won’t be faced with more gridlock and more acrimony on Capitol Hill — in short, a dysfunctional government that is incapable of dealing effectively with America’s serious economic problems.

With the liberal Obama Administration and a more conservative Congress at loggerheads, it is likely that America’s central bank will, by necessity, be the only agency capable of acting one way or another in the face of continuing recession-like economic performance, especially persistently high unemployment.

America’s voters and politicians are understandably impatient — and so is the Fed. All of us want to see policies that will quickly right the economy, rev up business activity, and put the unemployed back to work. But, unfortunately, a quick fix is not possible.

Structural Problems Require Structural Solutions

Few recognize or will admit that today’s economic problems are structural and were decades in the making, a consequence of excessive consumer and government spending that was bankrolled by household and public-sector borrowing and insufficient productive investment. America spent, not on developing our national infrastructure or developing 21st century industries or training students and the workforce for the jobs of tomorrow.

Instead, we became a nation of shopaholics, buying things we didn’t need with money many of us didn’t really have, while our government spent excessively on the cost of empire and on social programs that were of admirable intention but no one wanted to pay for.

Countercyclical monetary and fiscal policies cannot fix these structural problems. To thrive again, we must reduce our outstanding debt — measured as a percentage of gross domestic product or national income.

Understandably, our creditors — both foreign central banks and institutions who hold much of our public-sector debt and the banks who hold much of our mortgage and consumer debt — are reluctant to pile on more questionable debt. And, our household sector, rightly, is cutting spending in order to lessen their debt burden or build personal savings.

Meanwhile, raising taxes to achieve public-sector adjustment is neither politically feasible — and as we are beginning to see in Western Europe (Ireland, Portugal, Greece, and France, for example) fiscal restraint can backfire, reversing or slowing the hoped-for economic recovery.

Welcome Inflation

So this leaves the job up to the Fed. All the central bank can do is print more money — what they call “quantitative easing” as if a fancy name makes it more palatable.

And, if they’re smart, the Fed could channel some of this new money to sectors most in need or most likely to contribute to a revival in the long-term economic health and wellbeing of the nation and give employment a quick boost. For example, they could buy bonds specifically intended to finance highway, railroad, seaport, and airport rehabilitation and expansion . . . or the development of energy-producing projects . . . or increasing wireless bandwidth.

Printing more money may raise the hackles of sound-money advocates and surely won’t be appreciated by foreigners holding U.S. debt — but inflation may be just the potion that could ultimately restore economic equilibrium by devaluing our debt in real terms and reducing its burden the economy expands more quickly in nominal terms, reflecting not only real growth but also inflation. And, if wages rise with prices, a few years of moderate inflation here at home could be politically palatable.

Importantly, as if to prepare financial markets for future policy adjustments, central bank officials have begun talking about raising the Fed’s informal inflation target from two percent to a formal target somewhat higher and/or explicitly targeting future levels of nominal gross domestic product consistent with higher inflation across the U.S. economy.

Inflation-producing policies, particularly if pursued in unison with the other mature industrial nations (Western Europe and Japan) — what might be called “cooperative devaluation” — would also force these countries’ currencies along with the U.S. dollar lower against the grossly undervalued Chinese yuan, leaving Beijing powerless to stop its currency’s up-valuation without taking on increasing and unwanted quantities of depreciating foreign debt and, at the same time, boosting growth in its own domestic money supply.

Managing monetary policy to produce a step up in U.S. consumer price inflation and a depreciation of the dollar against the currencies of countries running persistent current account surpluses — and channeling resources to those sectors most likely to support a return to America’s long-term economic revival — makes sense.

One way or another, we believe that the U.S. and other mature industrial economies are facing an extended multi-year stagflation — sluggish economic growth possibly punctuated with periods of actual recession, much like the decade of the 1970s. And, like the 1970s, also a period of rising of rising commodity prices and high inflation despite high rates of unemployment and low capacity utilization, what is now called “slack.”

Wise policies may lessen the pain and accelerate the return to economic health. But, whatever policy path we choose, the United States faces difficult times that will be reflected in a continuing long-term appreciation in the price of gold.

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Monetary Policy, Competitive Devaluation, Inflation Targeting . . . and the Future Price of Gold

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Suddenly, our long-standing forecast of $1500 gold — possibly by the end of this year — doesn’t seem so far-fetched . . . and, one by one, many economists, analysts, and investors are ratcheting up their price targets to keep pace with the market.

The U.S. dollar price of gold is now up more than 20 percent this year and looks certain to score its tenth consecutive annual increase in a decade.  By comparison, U.S. equities, measured by the Dow Jones Industrial Average or the S&P 500, are up a meager four-to-five percent year to date.

No Bubble Here

Notably, the yellow metal’s recent advance does not look like a developing bubble or feeding frenzy driven largely by institutional traders and speculators operating in derivative markets.  While they have played a role, the price surge owes more to geographically diverse physical demand by the whole gamut of investors — from small-scale retail buyers of bullion coins and bars to large-scale funds acquiring physical gold directly and through gold exchange-traded funds.

And, so far, we have not seen a sizable reverse flow of old scrap (secondary supply) from profit-takers in the price-sensitive markets of India, Turkey, and the Middle East — what my good friend Tim Green, gold historian and author of The Ages of Gold, calls “the mood of the souks.”  The mood of the souks, whether they’re buying or selling, is often a good predictor of imminent price developments.  So far, the mood remains somewhat constructive — but history suggests this can change very quickly.

Caution remains essential.  Gold prices rarely move straight up.  When they do, you can be sure of an imminent reversal.  Indeed, I expect significant two-way volatility will continue to characterize gold’s upward march with big declines leading some to prematurely announce the end of gold’s bull market.

Even a swift drop back down below the $1300 an ounce level — or even lower — without a dramatic and unlikely reversal in gold’s bullish fundamentals would not diminish my enthusiasm or cause me to alter my long-term forecast of $2000 an ounce gold, followed by $3000, and possibly much higher in the next few years.

Multiple Pistons

As I have stressed in past reports and speeches, gold’s ascent reflects many factors, among them: growing jewelry and investment demand from China, India, and other emerging economies; the rise of gold as an “asset class” and unprecedented institutional investment demand; the new “gold-investment infrastructure” that makes gold more readily accessible to more investors around the world; the cessation of large-scale gold sales by Western central banks and the rising appetite by a number of emerging-nation central banks to accumulate gold reserves; the price inelasticity of gold-mine supply and the likelihood that mine output will stagnate for years to come; and, of course, the monetary/fiscal policy mess in the United States, Europe, and Japan.

Currency Wars

Although gold’s decade-long ascent has been powered by multiple pistons, the latest sharp move up was triggered principally by rising expectations of more money-supply creation by the Federal Reserve and the central banks of a number of other major economic powers.

In recent days, it has become increasingly apparent that the United States, the Eurozone, the United Kingdom, Japan and other major economies may be heading into a period of competitive devaluations and still more aggressive monetary creation.

Similarly, China and some of the other strong-currency countries are acting to slow revaluations of their own currencies in order to maintain a competitive edge in world markets.

Central bankers everywhere are responding to domestic political pressure to promote domestic employment and income growth — believing that exchange-rate undervaluation will boost exports, restrain imports, and support its local economy.

This is the wrong medicine for what ails the world economy.

Rather than boost world trade and global business activity, these policies — like the “beggar thy neighbor” trade barriers erected in the midst of the Great Depression — will retard economic expansion and hurt employment everywhere.

At the same time, these policies will boost world commodity prices — and domestic inflation in countries seeking to win the currency devaluation game.

Stagflation Ahead

Unfortunately, what I foresee for the U.S. and other mature industrial economies is an extended multi-year stagflation punctuated with periods of actual or near recession, much like the decade of the 1970s.  In fact, we are already there with years to go before a full restoration of economic health and rising prosperity.

Mirroring the experience of the 1970s, we are also in the midst of a great bull market for gold — with gold prices set to zoom in the years ahead as commodity prices rise and inflation accelerates.

Inflation Targeting

U.S. policymakers and many private-sector economists tell us that inflation is not and will not be a problem because of low capacity utilization and high unemployment — what they are calling economic “slack.”  Instead, we are told deflation is the problem and, in this Alice-In-Wonderland world, inflation is the solution.

Recent statements by Fed officials suggest the central bank may soon embark on a new tack of targeting an increase in consumer price inflation, possibly to an annual rate of three percent or more.  With nominal short-term interest rates already near zero, they suggest a pick up in inflation will push real (inflation-adjusted) interest rates into negative territory and stimulate borrowing by households and businesses.

What they aren’t saying, but just as importantly, higher inflation will raise growth in nominal personal income and nominal gross domestic product — thereby reducing the burden of existing debt and reducing the debt-to-income and debt-to-GDP ratios back toward historical norms.

History Lessons

Speaking of history, slack in the 1970s did not prevent a sharp rise in commodity prices and an acceleration of U.S. consumer price inflation to double-digit rates late in the decade.  It is conveniently forgotten that historical episodes of high inflation and hyperinflation have not been periods of robust business activity.  Quite the contrary as demonstrated by Weimar Germany in the 1920s or Zimbabwe today.

Remember, inflation is, first and foremost, a monetary phenomenon — too many dollars and too much debt relative to the available supply of goods and services.  And, there is no limit to the Fed’s ability to create more dollars.  It is only a matter of time before the past and continuing rise in money supply, what the Fed calls quantitative easing, and the need to finance huge U.S. Federal budget deficit, result in an acceleration in U.S. consumer-price inflation.

Listening to the Fed

Recent announcements by Federal Reserve Board Chairman Ben Bernanke and other Fed officials have been laying the foundation — and preparing the financial markets — for a further round of “quantitative easing,” Fed speak for buying U.S. Treasury securities, the counterpart of which is the creation of more high-powered money.

In its official statement following September’s meeting of the Federal Open Market Committee (FMOC), the Fed’s policy-setting group, it said it is “prepared to provide additional accommodation if needed to support the economic recovery. ”

Many Fed-watching economists now believe the next big change in monetary policy will be announced immediately following the FOMC meeting in early November.  If so, this next phase of monetary accommodation could give the gold market another significant upward jolt.  But if gold investors are over-estimating just how far the Fed is willing to go at this time, gold prices take a tumble.

Rather than announce another massive bond purchase with a finite end, as they did in March 2009 when it launched its program to buy $1.7 trillion in Treasury and mortgage-backed securities, now the Fed will probably shift to open-ended, occasional purchases of Treasury and possibly other securities with no fixed end date.

Ostensibly, this will allow the Fed to limit the size and timeline of this coming round of quantitative easing, what Fed watchers have already dubbed “QE2.”  And, wording to this effect will probably pepper their public policy statements.

But, it also will give the Fed latitude to pursue a larger and longer stimulative program of money creation, a course it will likely steer as the evidence builds of a prolonged “double-dip” recessionary economy, a scenario we have been predicting for more than a year now.

I think the Fed could easily wind up purchasing another trillion dollars or so of Treasury, mortgage, and maybe even private-sector debt in the next year — more or less the entire annual U.S. Federal budget deficit — a stimulative monetary policy that would be tremendously bullish for gold.

To paraphrase Nelson Bunker Hunt, who reportedly lost a billion dollars trying to corner the silver market in 1980, “A trillion dollars ain’t what it used to be.”  But it’s quite enough in Federal Reserve monetary creation to give gold quite a lift.

CPI - More Than Meets the Eye

At the November FMOC meeting the Fed may, in addition to launching QE2, also raise its “informal” inflation target from two percent to an “official” inflation target of three percent or more.

While most investors may believe the accuracy of official U.S. consumer price data — apparently the Fed does too — I believe the Consumer Price Index is under-reporting actual inflation by at least a percentage point and possibly much more.  This makes inflation targeting a risky business because the compass by which the Fed will steer is itself flawed.

A number of factors skew the official U.S. consumer price statistics downward:  First, the imputed cost of housing has been reduced by falling home prices, even though most of us are paying more for a roof over our heads.  Second, since 1990 the index has been based on a variable basket of goods and services that reduces the weighting of more expensive purchases and increases the weighting of less expensive goods and services.  Third, the CPI is adjusted downward to account for the qualitative improvements in the goods and services we buy, even though we might have been just as happy with last year’s model.

Although many investors and economists in and out of government do believe the official data, most consumers are feeling the effect of rising prices for food and energy — which policy makers avoid by focusing on the “core” rate of inflation that excludes these categories.

Policy makers also look at the yield differential between ordinary Treasury securities and “Treasury Inflation Protected” securities, the so-called “TIP spread,” as an indicator of inflation expectations in the financial markets.  The TIP spread reveals that most investors remain relatively unconcerned about a serious acceleration in U.S. consumer price inflation.  Or, it could be that the Fed’s purchase of securities is diminishing the reliability of the TIP spread as an indicator of inflation expectations.

Choosing to see inflation as benign and talking about deflation fears gives the Fed and other Washington policymakers leeway to navigate the inflationary course they are now pursuing.  Over time, more investors will migrate to the inflation camp — recognizing the true long-term inflationary consequences of the Fed’s loose-money, quantitative-easing, and dollar-bashing policies.  And, as they do, some will seek the safety, security, and inflation-protection of gold.

Few seem to remember that it was “only” an inflation rate around four percent that pushed President Nixon to impose “emergency” price and wage controls in August 1971, simultaneously slamming shut the U.S. Treasury’s “gold window,” and severing the last official link between the dollar and gold — thereby triggering the decade-long rise in the metal’s price.

Transmitting Inflation Abroad

Quantitative easing is also the mechanism through which the Fed attempts to devalue the U.S. dollar against other currencies.  In effect, the Fed purchases foreign currencies with newly created dollars.  In turn, efforts by other countries to devalue their currencies or maintain relative undervaluation, as in the case of China, requires their central banks to purchase dollars with their own newly created money.

So, efforts by a number of countries to manage devaluations or under valuations of their currencies will boost money supply growth in the various countries playing the game — and will globalize the coming acceleration in inflation.

As investors around the world see rising commodity prices and accelerating consumer-price inflation — not just in the United States but also in their own countries — many will turn to gold to protect the real value of their savings and wealth.

Filed under: Reports | American Precious Metals Advisors, central banks, economics, economy, gold, gold investment, gold price, inflation, Jeffrey Nichols, monetary policy, money supply, Quantitative Easing, U.S. dollar|No Comments

GOLD: Summer Consolidatation — Bull Market Alive and Well

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Gold prices have fallen sharply in recent weeks from their all-time high over $1265 on June 21st in New York.  By mid-July, gold was briefly below $1180 — a drop of some seven percent.

Faint-hearted gold investors need to remember that bull markets never move straight up.  When they do, it’s called a “bubble” . . . and bubbles do burst.

Instead, this market is moving up — and will continue to move up — in a stepwise pattern with occasional high volatility and big corrections on the road to much, much higher prices in the months and years to come.

For the most part, this summer’s gold-price weakness reflects two recent developments:  First, the reassessment of U.S. economic prospects by some gold traders and investors . . . and, second, an abatement in perceived European sovereign risk.

The economic news in recent weeks (particularly indicators of retail sales, consumer confidence, business inventories, housing starts, home prices, residential construction, etc.) is prompting rising expectations of an intensified U.S. economic downturn — the so-called “double dip” — and with it we are seeing renewed and growing concern about U.S. consumer price deflation.

Meanwhile, across the Atlantic, a successful refunding of some Greek government debt brought a collective sigh of relief from world financial markets . . . and the rush from Euros into safe-haven assets, namely the U.S. dollar and gold has, for now, abated.

None of this has, in any way, reduced our long-term bullish view of gold-price prospects.

In fact, the recent sell-off — and any further short-term price decline that may occur in the next few days or weeks — simply makes gold that much more attractive to long-term investors.

Double Dip to Stagflation

Unlike mainstream economic forecasts — and indirect opposition to the public predictions of Fed Chairman Bernanke, Treasury Secretary Geithner, and the Obama Administration’s economic minions — we have long expected (and discussed on this NicholsOnGold website) another U.S. business-cycle downturn followed by years of sub-par economic growth for the U.S. economy.

As readers know, we’ve long held the view that the U.S. economy would sink back into recession or, at best, a long period of sluggish growth insufficient to produce any meaningful gains in employment.

Longer term, we see years of “stagflation” for the United States and European economies — with sub-par economic growth, unacceptably high unemployment, and a troubling rise in inflation led by higher prices for many commodities, much like we saw in the 1970s.

For more on our U.S. economic forecast, see our recent post “Gold and the Double Dip.”

More Inflation Ahead

And, unlike most mainstream economic forecasts, we see accelerating inflation — NOT deflation — on the road ahead.

Inflation is the flipside to the monetization of Federal government debt, rapid money growth, and a loss of confidence in fiat money.  As the supply of U.S. dollars continues to grow more rapidly than the demand for money, each dollar becomes worth less (or some would say “worthless”) and the general price level rises.

Not only is the demand for dollars growing less rapidly at home due to sub-par business activity, high unemployment, a rising savings rate, and a loss of confidence in the economy and those in the economic driver’s seat . . . but the demand for dollars from America’s chief financiers, especially foreign central banks and in particular the People’s Bank of China, is also slowing — and this, along with a weakening U.S. economy, will push the Fed into a still-more expansionary and inflationary mode.

Deflationists and inflation doves say that we needn’t worry about inflation — because with so much slack — idle capacity and unemployment — in the economy, there’s plenty of room for rising economic activity and money supply growth without inflation.

What they have forgotten is that throughout thousands of years of recorded economic history most periods of persistently high inflation have occurred not when the economy was growing vigorously but when the economy was sluggish or sinking . . . and confidence in money was eroding.

Today, we are witnessing a loss of confidence in the dollar both at home and even more so abroad, that is capable of driving inflation higher even in the absence of high rates of capacity utilization and low rates of unemployment.  This loss of confidence has already contributed to the rise in gold prices over the past few years . . . and will continue to drive gold still much higher in the years to come.

Back to Europe

Returning to the causes of the current gold-price correction, we also think the abatement in perceived European sovereign risk has nearly run its course.  Rejoicing that Greece completed its latest sovereign debt refinancing without a hitch will soon be replaced with new worries as other countries come to the financing trough and find the markets less accommodating.

It went without much notice last week when Portugal was again downgraded by one of the debt-rating agencies.  And it went with even less notice this past weekend when Hungary’s talks with the IMF and the European Union over financial aid and debt reduction broke down in disagreement.

Europe’s sovereign debt crisis will soon heat up as other countries are downgraded by the rating agencies, as German remains recalcitrance to bail out the more profligate euro-zone nations, and even more unwilling to help other European Union members that retain their own currencies, like Hungary and Poland, bridge their sovereign financing requirements.

Indeed, Germany is calling on other European nations to tighten their own fiscal seatbelts by cutting spending and raising taxes.  This is a roadmap to slower economic growth if not outright recession — and is likely to lead to a worsening of the sovereign debt crisis, continuing downgrades by the ratings agencies, and further capital flight into gold by Europeans and others seeking protection from increasing difficult times for Europe’s economy and common currency.

Filed under: Gold Briefs | American Precious Metals Advisors, deflation, economics, economy, fiscal policy, gold, gold investment, gold price, inflation, Jeffrey Nichols, monetary policy, money supply, Quantitative Easing, sovereign risk, U.S. dollar|No Comments