Zealous Deflationist Sheds Gold Doubts

For edition of January 22, 2008

Gold at $10,000 an ounce? Gurus and hard-money advocates have been predicting it for decades, ever since currencies began to seriously decouple from bullion in the 1930s. I’ve been skeptical of such forecasts myself, mainly because my deflationist imagination has always envisioned a world in which public and private bankruptcy had become pervasive. With credit unavailable, cash in extremely limited supply, and asset values wiped out by forced liquidations, who, I asked, would supply the bidding power to push bullion quotes into the stratosphere? Arab oil producers? Think again, for they would be energy-rich but cash poor, their financial wealth turned to confetti like everyone else’s. Even their ability to accumulate new stores of real wealth in the form of gold would be in doubt, since, if they were to demand ingots in exchange for crude, global consumption of oil would collapse to subsistence levels.

Nor will the sovereign governments of the West have the wherewithal to replenish their bullion vaults, since the fiat reserves they would trade for gold – overwhelmingly in dollars and dollar-denominated assets now -- would have become worthless. And while the U.S., Europe et al. could in theory make official purchases of gold with tax dollars, that would only serve to entrench deflation by institutionalizing the worst Keynesian nightmare imaginable.

Fiat Still Not Outed

No, there doesn’t seem to be an obvious buyer for gold at $10,000 an ounce once you have acknowledged that the impending global economic collapse will reduce paper assets to worthlessness. But that doesn’t mean an ounce of gold cannot get bid up in the meantime to $10,000, however fleetingly, before the fiat money that is still accepted in exchange for gold has been exposed as a fraud.

How ironic, then, that even as this day of reckoning has become almost palpable, gold bugs continue to fret and gnash their teeth every time the price of bullion corrects $50 or more. Take it from a deflationist who once scoffed at the notion of $10,000 gold: This rally is the real deal, and the $1,000 supposed “barrier” is looking more and more to me like a launching pad. Deflation might eventually knock gold back down to earth, so that bullion will have “merely” retained its purchasing power in spades, but there is a lot of inflating to be attempted (futilely) by the central banks before that is likely to occur.

Remodel 50 Million Kitchens

Meanwhile, that this attempt cannot possibly succeed is at the heart of any deflationist’s argument. We can see the reasons for this already. For one, the chicken-in-every-pot that the U.S. government is about to offer Americans via a tax rebate is so puny and belated a “solution” as to be laughable. Even if such Keynesian quackery could work, and even if the government were to enact a big enough giveaway to thwart deflation for perhaps a year or two – say, by offering every household a new Chevy Tahoe or a kitchen-remodel – it would only put us that much deeper in debt, since Congress would be spending money created from thin air rather than raised through taxes. Make no mistake, this fiscal stimulus package is a cynical political hoax, and the fact that the stock market got almost no lift from it shows that investors understand this implicitly.

What they do not fully understand, at least not yet, is that providing effectively unlimited credit to the banking system is not the same as hyperinflating. Allowing the banks to re-jigger their books so that they can at least appear solvent for a little while longer will delay the day when one of them fails so hard it takes others down with it. But this will have almost no effect on the consumer economy, which accounts for about 70 percent of GDP; nor will the mere, short-lived illusion that the banking system has stabilized engender the kind of hubris it would take to get home prices moving in the other direction.

Sell Gold, Buy Chrysler?

Another reason the U.S. government's attempt to pump up the economy must fail is that we are the only country that appears both eager and willing to promote all-out inflation. Europe has rejected an easing smackdown; instead, fearing global systemic risks, they have arranged effectively unlimited lines of credit to European banks, as well as bottomless drawing rights for a U.S Treasury that at some point will need to borrow vast quantities of euros to mop up dollars that the rest of the world has ceased to want.

With that day almost surely in prospect, any selling of gold by investors at these supposedly loft levels is premature, just as any decline of $50, or $100, or even $200 in bullion’s price is fundamentally unwarranted. If you think the stimulus measures being promoted by the government will help restore the U.S. economy to health, then by all means, sell your gold assets and buy shares in Chrysler. For our part, we will reiterate our belief that gold has been, and will continue to be – at least for the foreseeable future -- the no-brainer investment of our lifetime.