18 December 2008

Gold virus spreads

"Gold is almost surely on its way to an inflation-adjusted high, which is approximately $2,500 (based on January 1980 high of $870 an ounce), depending on whose inflation figures are used.

While the inflation that eventually will accompany the $2 trillion manufacturing of American currency this summer and autumn will help gold in traditional economic terms, I believe the best one-word, tipping point phrase for the looming precious metals phenomenon is still counter-party risk.

Here is a primer from former economist, author and GoldMoney.com owner James Turk on why 2009 will be different than 1932. I chatted with him via an electronic mail exchange today (Wednesday). My question to him: How can gold rise if the American dollar (and other currencies) stay flat or “dry up” in a rapid and severe deflating of economies and consumer prices?

“Dollars became scarce in the depths of the Great Depression for one reason. The gold standard then in place restricted the number of dollars that could be created by the Federal Reserve. Therefore, as people sought gold to avoid the risk of bank failures, they redeemed dollars for gold, which forced a contraction in the quantity of dollars in circulation,” Mr. Turk tells me.

Deflation was the result. “The purchasing power of both gold and the dollar rose, assuming you had the good fortune to hold dollar cash or to have your dollars on deposit in a bank that did not fail. Gold is a safe-haven because it does not have the counterparty risk that comes with holding dollars,” Mr. Turk notes.

Our tracking of the manufacture of paper currency rolls at U.S. Mints, defined by the St. Louis Adjusted Monetary Base, concurs with the newspaper coverage today: The Federal Reserve will use any and all means to sidestep a catastrophic deflation of prices and “drying up” of currency.

“Today there is no constraint on the quantity of dollars that can be created, and the Federal Reserve announced yesterday that it will ‘employ all available tools’ to flood the system with dollars in the hope that low interest rates and easy money will jump-start a moribund economy,” James Turk says. See James Turk’s commentary.

Currencies, starting with the dollar, eventually will suffer from the ballast blasting that always comes with additional currency flooding a nation and a planet. Yet the purchasing power of gold can and will rise, albeit some of its heft punctured by those inflationary dollars."

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Patrick said...

What most gold bugs don't realize is gold has the counter-party risk of people knowing where you live.

Kevin said...

thanks for this excellent post. i wonder if Turk's expectation that "currencies, starting with the dollar, eventually will suffer" is now under way.